Study: Competition reignites the European debt market

The arrival of alternative lenders in Europe is driving up leverage and putting pressure on pricing, the DLA Piper report finds.

The intensification of competition between lenders and debt products was the most profound change in the European debt markets during 2014, according to a survey of more than 300 debt practitioners.

Eighty-four percent of respondents believe competition between lenders increased, law firm DLA Piper found in its European Acquisition Finance Debt Report for 2015. And 81 percent of respondents, including debt providers, advisors, sponsors and corporates, believe competition between debt products was more pronounced.

Optimism and confidence has taken hold of the European market and the sheer breadth and depth of debt on the supply side should continue, panellists agreed at the launch of the report yesterday (24 February).

However, James Ranger, co-head of acquisition finance mid-markets team at Lloyds Bank, questioned whether some fund managers were getting paid enough for the risk they are taking on, particularly in light of looser covenants in the market.

“We are concerned that some credit funds are prepared to sacrifice covenants for yield in the mid-market. These loans are largely illiquid and there is limited opportunity to trade out if performance deteriorates. We are not convinced that risk is being properly priced and, in some situations, lenders are driving towards a future car crash,” Ranger said.

Notably, after years of sluggish new deal flow, respondents for the first time in three years, predict more traditional primary management buyouts in 2015 than refinancing transactions, at 20 percent versus 18 percent. Secondary or tertiary buyouts are expected to be the top deal type by volume however, according to 26 percent of respondents.

At the start of 2014, private debt funds were expected to take a big share of the European lending market, DLA found. However, banks stepped up their activity and for strong credits, they are offering higher leverage, lower pricing and in some cases looser terms.

“If the credit is strong, banks will increase their leverage capacity aggressively, price debt relatively cheaper than where funds can get to and retain the credit. Funds come into their own when the credit isn’t as strong, or has a quirky structure and the banks just can’t get comfortable as quickly,” Alexander Griffith, debt finance partner at DLA Piper, commented in a statement.

At the higher end of the leverage spectrum, the typical total debt leverage cover on senior and second lien loan packages, is expected to be 7.5x. On unitranche and super senior, it is expected to be 4.7x. Loan margins and arrangement fees are also expected to fall. Fifty-four percent of bank and alternative lender respondents plan to increase acquisition finance lending targets in 2015 and new lending funds coming to market will put further pressure on pricing. More than 80 percent of respondents expect a typical senior term loan A margin to be below 4 percent in 2015, up from 60 percent in 2014.

In the mid-market, 33 percent of respondents expect unitranche to be the most common non-bank acquisition debt finance structure in 2015, followed by mezzanine (28 percent), secured highyield bonds (23 percent), second lien (11 percent) and unsecured highyield bonds (five percent).