By Claire Ruckin
LONDON (Reuters) - Bank lenders to European leveraged loans are increasingly rejecting deals due to aggressive pricing and documentation, but are being quickly replaced by institutional investors targeting higher-yielding term loan B paper.
Banks have traditionally been big lenders to European leveraged loans, unlike in the U.S. market where the buyside is almost exclusively made up of institutional investors such as CLO funds and mutual funds.
Participant banks sitting on large amounts of liquidity (including AIB, Bank of China, CIC, DZ Bank, Erste Bank, Mediobanca, Mizuho, MUFG, Raiffeisen Bank and SMBC) stepped up lending in 2016 after getting comfortable with covenant-lite loans, which have fewer protections for lenders. And up until this summer, banks were representing up to 25% of syndicates on some deals.
Since then, however, they have been far more selective, dropping back to below 10% of lender groups.
“A load of banks are pulling back from the market,” a senior banker said.
Bank’s rejection rates are rocketing on deals such as the highly leveraged US$1.7bn (£1.2 billion) debt financing backing the buyout of UK intellectual property services provider CPA Global by US private equity firm Leonard Green & Partners.
Aggressive deal terms are challenging banks’ more conservative business models and balance sheets, while Europe’s booming and competitive buyside continues to move to a more flexible US-style institutional model.
“It is very challenging with new margins at 300bp, no covenants, high leverage, loose documents and adjusted Ebitda that are frankly bordering on fantasy,” the senior banker said.
Although prudent, this strategic u-turn is hitting income for well-capitalised European, Japanese, Indian and Chinese banks that have scaled back participation, although some are still infrequently buying term loan B paper from well-known clients.
“Over the summer we were dropping out of everything - but if you don’t do deals, you don’t make any money. We have got a bit more willing to accept some deals over the last month or so, but we are still very selective. If it is a core client we are trying to do the deals,” the senior banker said.
Japan’s SMBC, on the other hand, is resisting pulling back from Europe’s leveraged loan market. In fact, it has recently begun making larger commitments in a bid to increase market share, sources said.
FLOOD OF CASH
The decline in banks’ participation in Europe’s term loan B market is not having an impact on dealflow or adversely affecting syndications, as liquidity continues to flood in from alternative lenders.
An increase in managed accounts is helping to fill the liquidity gap as pension funds, insurance companies, sovereign wealth funds and high net worth individuals seek higher returns. Managed accounts often now account for up to 50% of a deal, compared with 20% or less previously, sources said.
Institutional investors are often prepared to take a view on “story credits” in return for higher yield - unlike banks, which are more inclined to reject difficult deals.
“Deals are happening with funds. Banks are selective and have less tolerance for weaker credits. You can fix things with yield for funds, but not for banks, which won’t do a deal if it doesn’t stack up,” a second banker said.
Banks’ lengthy internal processes are also contributing to their disintermediation as the length of time it takes to syndicate term loan B deals continues to shrink, which also favours more nimble institutional investors.
“Banks are getting frozen out of deals because they can’t cope with the timetable unless they’re existing lenders,” a syndicate head said.
Private equity firms and arranging banks have accelerated syndication timetables this year. New leveraged buyout financings can be wrapped up in a couple of weeks, dividend recapitalisations can be placed in a week, and repricings and refinancings sold in a matter of days. Banks can sometimes take weeks to get internal approval to do a deal.
“Funds are fast and take a week to come back, but banks have to go to credit committee and another committee. Banks are more labour-intensive and not as focussed as funds,” the second banker said.
(Editing by Christopher Mangham)