Hedge Funds Beating Banks to LBO Loans in Europe: Credit Markets

Sep 04, 2014 5:58 am ET

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Sept. 4 (Bloomberg) -- The leveraged loan market is becoming riskier in Europe as private-equity firms shun banks in favor of hedge funds and other institutional investors to finance buyouts.

Of the seven junk loan deals totaling 2.6 billion euros ($3.5 billion) issued last month, none featured portions where principal has to be paid down in installments, the type of senior debt usually sold to banks, according to data compiled by Bloomberg. Borrowers are also seeking to loosen investor protection, with so-called covenant-lite transactions surging to 6.4 billion euros this year from 3.75 billion euros in 2013, the data show.

“Funds are asking for more paper and private-equity owners are taking the chance to structure riskier and more aggressive deals,” said Paolo Malaguti, founder of Aston-Corp Analytics, a London-based provider of financial data and analysis to leveraged-loan and high-yield bond investors. “They are pushing for loans with fewer covenants and with higher leverage which often banks are reluctant to take on.”

The move toward riskier structures is bringing Europe closer to the U.S. market, where bank participation in leveraged lending is typically limited to revolving credit facilities and small portions of loans. Amortizing debt tranches accounted for just 4.4 percent of all U.S. leveraged loans issued by buyout firms in the last five years, of which 39 percent were covenant- lite, Bloomberg data show.

Principal Repayments

Europe’s private-equity owned borrowers are taking advantage of demand for higher-yielding assets to structure loans that allow them to reduce the amount of cash needed for regular principal repayments. August was the first month since March 2010 when not one leveraged buyout deal included amortizing debt, compared with an average of 15.8 percent in the past five years, data compiled by Bloomberg show.

“Europe is definitely moving closer to U.S.-style structuring,” said Aston-Corp’s Malaguti. “Even smaller or regional deals where you would have once expected large bank participations are now being largely financed via non- amortizing, institutional debt.”

When Bridgepoint Capital Group Ltd. refinanced the debt of Austrian fridge manufacturer AHT Cooling Systems GmbH last month, it swapped a 58 million-euro term loan A, the senior tranche that features an amortization schedule, with a covenant- lite term loan B that doesn’t have to repaid until maturity, according to data compiled by Bloomberg.

Higher Leverage

The London-based private-equity firm also increased the the loan by an extra 50 million euros, boosting its ratio of debt to earnings before interest, tax, depreciation and amortization to 5.5 times from 4.5 times, according to people familiar with the deal, who asked not to be identified because the terms are private. James Murray, a spokesman for Bridgepoint in London, didn’t respond to three phone calls and an e-mail seeking comment.

“Issuers have the choice, they don’t have to rely on commercial banks for capital,” said Michael Marsh, the London- based head of Goldman Sachs Group Inc.’s Europe Middle East & Africa leveraged finance capital markets unit. “When you have an amortizing debt tranche designed to appeal to commercial banks, almost by definition, you will have to have financial maintenance covenants. Institutional investors offer non- amortizing debt with longer duration and potentially on a covenant-lite basis.”

Stricter Regulations

Most banks are steering clear of covenant-lite loans because stricter regulations that came into effect after the financial crisis require lenders to set aside more equity against riskier debt.

German pharmaceutical company Aenova Group, owned by British private-equity firm BC Partners Ltd., last month discarded a 40-million euro term loan A that was part of the buyout deal syndicated in August 2012. Instead, it opted for a covenant-lite term loan B that pays 400 basis points more than benchmark rates, 100 basis points less than the portion of debt it replaced, Bloomberg data show.

Matthieu Roussellier, a spokesman for BC Partners employed by Greenbrook Communications, declined to comment on the refinancing.

“The cost of taking out non-amortizing debt from a non- bank lender is only marginally higher than that of amortizing loans,” said Fenton Burgin, partner and head of U.K. debt advisory at Deloitte LLP in London. The possibility of getting looser terms on higher-leverage deals without repayment schedules “is a very compelling cocktail for many private- equity sponsors,” he said.

--With assistance from David Cox and Tom Freke in London.