Hungry for more in the European leveraged loan market

Long dealt a bad hand in documentation, investors may have assumed that the global pandemic would make borrowers less demanding. Their raised hopes could well be dashed.

Having shut down like so many other things following the covid-19 outbreak, the European leveraged loan market has been slowly easing back to life. When we last reported on this market, it was in the expectation that it would be greatly changed – with lenders standing to benefit. But, having listened with interest to an S&P Global seminar on 2 June, that now seems like a bold bet.

A variety of participants – including from S&P, fund managers, banks and law firms – reflected on a market that they expected would recover quickly because of the level of appetite. “The demand for leveraged loans will grow massively and it will end up bigger than the high yield bond market,” said one. “Yields have collapsed and people need income.”

The level of demand was even expected to enable the market to shrug off much of the impact from a potential second wave of the virus. The view was that levels of outflow would be significantly less than those seen in March.

It was also anticipated that demand would continue to support high leverage. A chart that was shared in the seminar showed that, in the run-up to the current crisis, first lien/EBITDA multiples had risen to 5.4x, the highest level since 2004. There have not been many deals lately, so the evidence is scant, but few participants at the seminar were expecting leverage to be driven down any time soon.

And then there was the thorny issue of covenants. Those who assumed that investors would be able to turn the tables on borrowers when it came to loan documentation may be in for an unpleasant surprise. “I don’t see any meaningful move towards it,” said one seminar participant when asked whether we could expect to see the return of the maintenance covenant.

Demand is again the key factor. Given the choice of insisting on covenants or missing out on deals, investors are still more likely to back down and bite the bullet. There is even a view that sponsors – having been scared by the effects of the pandemic into wanting even greater control – may push for more borrower-friendly terms than before. Indeed, there are some signs in the clutch of issuances made over the last month or so of a further deterioration in the documents from the investor’s standpoint.

There are some signs of change in the market. Towards the end of last year, Jeanologia – backed by Carlyle Group – was the first European sponsored transaction with pricing on the debt directly linked to environmental, social and governance criteria. The ESG focus remains firmly in the spotlight, and more deals of this ilk may be expected.

Nevertheless, the mood at the seminar was that investors in Europe’s leveraged loan market should not expect any radical change in their relationships with borrowers any time soon. However counterintuitive it may feel amid increasing economic strife, many think the bandwagon in this part of the investment universe will keep on rolling.

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