Getting crowded

The leveraged finance community in Europe have plenty to be working on: the deal pipeline is filling up and the private equity firms have the appetite to acquire sizeable assets. But the problem is that a host of financiers have noticed this. Whether a senior or more subordinated debt or mezzanine provider: wherever you tread you are going to find several of your peers ahead and behind you. Is it time to start talking about a leverage finance overhang, ask David Hawkins and Philip Borel.

As the roundtable on European leveraged finance hosted by this magazine evidences [see p. 39 onwards of this issue], European LBOs are at once challenging and exciting the lending community. The excitement comes from the fact that there is rising demand for a wide variety of finance from sponsors, and the mood in the public equity markets suggests that M&A activity is going to increase through the year.

Sponsors don't simply ask but insist on their pound of flesh

Today, financial sponsors have the equity firepower to compete with pretty much any trade buyer for any asset. Operating single-handedly or by forming a small syndicate, the equity houses can meet any price and ensure that their multi-billion Euro funds can still be spread across a number of major deals. If they need only contribute between 20 and 30 per cent of transaction value in the form of equity capital, then a billion euro fund can buy five or so assets costing a billion euro each. Considering the number of buyout firms investing funds considerable larger than this, one begins to see why the banks are eager to resource their financial sponsor coverage groups.

And on the buy side there are a growing number of investors who have a seemingly insatiable appetite for paper from all corners of the yield and maturity spectrum. This includes the high yield funds and the CLO and CDO funds also. This latter group can each have paper from up to seventy deals tucked in them and they are continually trawling the market as recapitalisations and refinancings push and pull their portfolios.

There's no doubt that there is a ready market for leveraged product, and this has enabled the banks to sell down significant portions of the debt they underwrite. As part of this process, those that have big balance sheets are clearly making the most of them. Although some may point to the risks that this entails if interest rates climb upwards and default rates increase, most of the banks are presently pleased to be able to work their money as hard as possible.

Too much, even now
But it's not all plain sailing: everyone is finding the competition far more intense. The established senior lenders complain about second tier houses “giving deals away” to win business in the hope of securing a seat at the top table for subsequent transactions. And all of the banks talk about pricing getting tighter. As Simon Wakefield, Global Head of Acquisition Finance at SEB Merchant Banking says: “There is a lot of liquidity, and lead arrangers are being very aggressive to win mandates. This means offering more leverage, using your distribution capability to the full, executing extremely quickly and offering better pricing on subordinated debt.”

You can't help but wonder where all this money is going to go

With senior debt pricing in Europe staying pretty flat, the better margin business often comes further down the capital structure. But here the volumes are smaller and the possibility to land a nicely priced deal is still pretty remote. If you stick your heels in when negotiating with a sponsor, don't be surprised if a competitor steps straight in.

This problem is being felt by all the finance providers, including the mezzanine firms. Talk to the older houses and they are quick to comment about the huge amounts of capital that have been channelled into mezz funds including their own. As one director at one of these firms commented: “You can't help but wonder where all this money is going to go… people are climbing over each other to get into deals and we often all end up with slivers. That doesn't get your own fund very far, very fast.” The market in London was recently abuzz with comment, for instance, about a recent mezzanine transaction of £35m where 11 different mezz firms participated.

All of this is not lost on the sponsors: it presents itself as a great opportunity to turn the screw on the lenders crowded at your door. Said one partner at a UK buyout firm presently investing a mid-market fund: “We never have any trouble getting a bank to fall into line once we've signalled our wish to go proprietary with them. They're glad enough to have beaten off the others that we can get some useful terms kept in the documentation.” The banks themselves are all too aware of this state of affairs and will readily complain off the record about the sponsors and their investment bank advisers who, as one UK-based senior debt provider put it, “don't simply ask but insist on their pound of flesh.”

If you say no, sponsors may well find someone else to take the deal

The fact that leverage multiples have climbed back up to levels seen prior to the market traumas of the late 1990s has given a number of people pause for thought. A six-times EBITDA multiple applied to any company is asking quite a lot of the credit – especially if interest rates rise or exchange rate fluctuations depress revenues.

And the mezzanine providers, for one, are increasingly irked by what they regard as the banks' over-leveraging of companies. “Everything will often be right except the leverage when we look at a deal,” says Richard Collins, a director at UK mezzanine provider Indigo Capital. “You're seeing some lovely credits being swamped by the bankers pushing the leverage to the absolute limit.”

“We never have any trouble getting a bank to fall into line”

Sponsor-driven LBO loans 2003 Europe, Middle East and Africa

Rank Bookrunners Value ($bn) Deals Share (%)
1 Barclays Capital 7.317 16 16.6
2 RBS 4.539 14 10.3
3 Bank of Scotland 4.113 17 9.3
4 CSFB 3.823 8 8.7
5 ING 3.104 9 7.1
6 BNP Paribas 2.284 14 5.2
7 Deutsche Bank 2.011 3 4.6
8 Merrill Lynch 1.418 3 3.2
9 HVB 1.343 5 3.1
10 CIBC 1.192 5 2.7

RankMandated arrangersValue ($bn)DealsShare (%)1Barclays Capital7.7171814.62RBS7.0892513.43Bank of Scotland4.692248.94CSFB3.75187.15ING3.201136.16BNP Paribas2.560174.97Merrill Lynch2.47744.78Deutsche Bank2.29744.49Citigroup1.63533.110ABN AMRO1.46482.8RankEquity sponsorValue ($bn)DealsShare (%)1CVC Capital Partners6.0011011.42Permira3.13665.93Cinven2.88745.54Candover2.65645.05The Carlyle Group2.63074.96BC Partners2.37044.57Apax Partners2.21454.28Montagu Private Equity1.86543.59Merrill Lynch Private Equity1.64123.110Texas Pacific Group1.64123.1