I think at the moment we've got a confidence issue in what leveraged loans are worth in the secondary market. Those that do have liquidity are still fearful that there's more downside price risk in the assets that they can pick up so people are just sitting back on the sidelines and they're just seeing what the banks are going to do to sweeten primary syndications.
At the moment, we're still a couple of months away from year-end for a lot of the main underwriting banks. To avoid a lot of the market-to-market issues the banks have, they're simply pulling syndications or not actually attempting to syndicate. But we do know for a fact that a lot of the investment banks in particular, and the large underwriters of scale LBO transactions, are under intense internal pressure to offload their underwrites. That pressure will get greater and greater the nearer we get to each of those institutions' financial year-ends, where the last thing they want to be doing is posting large on-balance sheet liabilities to leveraged underwritings in their annual accounts that they had entered in quarters one and two of 2007. I suspect that the investor base will wait until the banks are prepared to suffer a lot more pain due to their approaching year-ends before they move in and take up some of this overhang, but at the moment it's very difficult to call.
I think most commentators are saying that the volume of leveraged loans stuck in the pipes equates to roughly six months' worth of normal market inventory. So this is a problem that could be with us into the first quarter of 2008. But with the year ends of all of these banks looming, they're going to be forced to do something. Much depends on how much the financial sponsors are going to want to help. There's talk today of some of the borrowers, the private equity funds, potentially looking to buy large chunks of the debt in their portfolio companies if they can negotiate a big enough discount. That might be one way to approach the problem.
I think what's for sure is that anyone who wants to borrow money in the current market is going to have to pay more. I think that covenant protection afforded to lenders will be much, much greater. Pricing is certainly going to go up. We know that there isn't much of a market for second lien in Europe at the moment, which means that leverage is going to come down. So we're going to be going back to the way in which a lot of deals were structured five, six years ago in terms of new deals.
Second lien is not on offer in Europe at the moment, which, by default, means that mezzanine is going to benefit – especially the handful of specialist European mezzanine investors, such as the likes of ICG, Babson, Alcentra and Park Square. I think that anyone who's borrowing money is going to have to work much more closely with the end holders of the risk to get deals done. So I do think that the current market is a big opportunity for specialist mezzanine investors.
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