S&P: loan market overheating

The supply-demand imbalance in the European loan market is leading to more highly leveraged transactions and more borrower-friendly terms, the ratings agency warns.

The leveraged loan market in Europe is showing signs of overheating, Standard & Poor's warned on Thursday in its latest report. 

“Low interest rates coupled with a continued supply-demand imbalance could lead to excessively borrower-friendly lending standards and more highly leveraged transactions,” S&P said.

Demand from both bond and loan fund managers for speculative-grade paper and the return of the CLO market have fuelled demand for leveraged debt. However, supply has not risen in line with demand, and the imbalance is leading to an increase in borrower-friendly terms and features on new issuance as well as a rapid re-pricing of existing loans, S&P said.

Credit quality is generally holding firm amid broadly stable credit conditions in Europe but if the imbalance continues it “could prove highly destabilising for credit quality,” the rating agency said.

A pick-up in M&A activity could temper the market's exuberance before it becomes irrational, S&P observed.

Taron Wade, a credit analyst at S&P, said: “The return of the market for CLOs, ample liquidity in the high-yield bond market, and investor appetite for higher yield are all fuelling leveraged finance activity.

“However, we see warning signs of the market overheating. Demand has outstripped supply, with insufficient loans and bonds to meet investor demand. This is because many companies have already refinanced their debt structures and extended their debt maturities. In addition, mergers and acquisitions, which are often funded by debt, remain below trend,” she continued.

New issuance with covenant-lite terms is becoming increasingly common and second-lien debt issuance is on the rise while some companies are repricing existing loans, in some cases only six months after the original loan came to market, S&P said.

Credit quality remains firm, however, and an average debt-to-EBITDA multiple of 4.7x in 2013 is still below its peak of 5.9x in 2007, S&P stated.

The leveraged finance market in Europe has made nearly a complete recovery from the global financial crisis, S&P said. Volumes in high-yield loans and bonds in 2013 reached €124 billion, close to the 2006 high of €133 billion. M&A deal flow in 2013 was around 30 percent below the 10-year European average, according to data from S&P Capital IQ.