December 12, 2016 / 4:20 PM / 9 months ago

LPC-Investors eye sterling premium on UK leveraged loans

Dec 12 (Reuters) - Activity is picking up in UK leveraged lending as private equity firms start to target middle market buyouts which have more attractive valuations after the sharp fall in sterling after Britain’s vote to leave the European Union in June.

Changing currency dynamics are also making British buyout deals more appealing due to the premium that sterling offers to compensate investors for lending in a less liquid currency, despite the uncertainty the Brexit vote has cast over the UK economy.

For US private equity firms with dollars to spend and European sponsors deploying euros, the 15% fall in the pound since the referendum is making the valuations of British companies more attractive.

“The change in the exchange rate has put them (US private equity firms) in a good position,” a mid market banker said.

UK leveraged loans are starting to pick up after a slow 2016, which was overshadowed by the Brexit vote and left investors unwilling to take risk in sterling.

British leveraged loan volume of £19.2bn for the year to date, is 48% lower than the same time last year, when £37.2bn of deals had been completed, according to Thomson Reuters LPC data.

Dealflow is starting to recover, however, after hitting a six-year monthly low of £124.9m in July, which was the lowest monthly volume since February 2010.

DEALS ANNOUNCED

EQT announced on Friday it will acquire UK veterinary care business Independent VetCare from Summit Partners using one of its euro-denominated funds. The financing package is expected to be around £150m. The Swedish private equity firm fought off competition from Bain Capital, Nordic Capital and Canadian pension fund giant Omers.

The sale of UK dentistry firm Oasis also attracted strong appetite from private equity firms. Advent, Ares and Swiss investment firm Jacobs Holding submitted final round bids before being gazumped by strategic buyer Bupa’s higher offer of £835m.

A smaller number of UK private equity firms with sterling funds are also continuing to invest in British companies. Direct lenders, including Pemberton, are also targeting the UK, and are seeking to exploit an anticipated slowdown in UK lending by foreign banks in the next five years after Brexit.

“Sterling-only private equity funds are deploying as per usual, and now you are getting the euro, swiss and dollar-based funds looking at the mid market and taking the view that sterling is cheap in the medium term,” a direct lender said.

Institutional debt investors are increasingly being lured to the market because the premium between sterling and euro-denominated deals has increased from around 50bp to as much as 100bp since the Brexit vote, he said.

“A number of investors are now looking at UK loans as an arbitrage. The cost of hedging is only up 25bp per annum but there is 85bp-100bp more yield,” he said.

A £180m all-senior buyout financing was syndicated in August for UK utility and infrastructure services company Morrison Utility Services and education firm Study Group refinanced an existing bond with a £230m-equivalent term loan.

“A month before Brexit everything was on hold, a couple of weeks after Brexit there was calm and now we are seeing very strong deal flow,” the lender said.

STRONGEST FIRST

The Brexit vote is, however, limiting the types of businesses that are able to tap the market, at least in the near term, to strong domestic businesses.

“These are all very good domestic-focused businesses immune to the broader pressures Brexit might bring. There is a well-developed bank and direct lender market prepared to support them.” a second banker said.

Around 70% of the UK buyout pipeline currently consists of healthcare businesses, a third banker said.

“I think it’s a reaction post-referendum that buyers are thinking there is still uncertainty out there but we can be relatively confident in healthcare - that that’s a sector if we put money in now it’s still going to be there,” he said.

The fledgling flow of deals could however stall as uncertainty grows in the run up to March next year when the government plans to trigger Article 50. (Editing by Tessa Walsh)

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