LONDON, June 2 (Reuters) - European leveraged loan borrowers are imposing tougher restrictions on which investors can hold debt in portfolio companies in a bid to strengthen their control over assets.
Buyout firms have taken advantage of the deep liquidity on offer in Europe and the supply-demand imbalance to secure lower pricing on loans, higher leverage ratios and weaker documentation.
Targeting transferability is the next stage of sponsors’ assault on investors as they become increasingly vocal on which investors they want to do business with.
“Investors are agreeing to so many restrictions because pricing has been pushed as low as it can go and leverage is as high as it can go. Now, borrowers are seeing what else can be given up,” a banker said.
Within the past six to 12 months, sponsors have stepped up efforts to control which investors can hold and access loans, seeking to prevent any fund from exerting too much influence or building a controlling stake.
Private equity firm Advent shocked the market in December by limiting any one investor from holding more than 10% of a jumbo €2.1bn-equivalent term loan to back French smartcard maker Oberthur Technologies’ acquisition of Safran’s biometrics and security business Morpho.
Since then, private equity firms have attempted to squeeze lenders further. Crucial language enabling fluid transferability has been removed from some credit agreements, for example, so investors can only “transfer with consent” as opposed to the more usual “transfer with consent, not unreasonably withheld”.
Sponsors have also clamped down on sub-participation (an arrangement where a new lender provides funds to an existing lender to lend to borrowers), in some cases not allowing it at all. In other cases, language in loan docs says that an event of default can only be triggered by a major event, rather than a small covenant breach. GOING, GOING… The suppressing of transferability has been worsened by an increase in covenant-lite deals and both bankers and investors share a consensus that a loan should - at a minimum - have either covenants or transferability, but be not devoid of both.
“You have to choose covenants or transferability. Investors rationalised [the relaxation of] docs by thinking if they didn’t like a deal or it went wrong, they could express opinion, not by bringing it to the table, but by leaving the table. If you limit their ability to step out, they are powerless,” a head of leveraged finance said.
Covenant-lite deals typically feature so-called springing covenants on their revolver tranches, which in the event of a default also trigger a default on the equivalent term loans. But sponsors are seeking to stipulate that there can be no cross-default between the revolvers and term loans, which would keep institutional investors (which typically only hold the terms loans) locked into a struggling deal.
Transferability - or the lack of it - is likely to prove a battleground on a new batch of potential financing packages that are backing auction processes, including Danish packaging group Faerch Plast.
Banks have resisted some of the requests, including pressure from sponsors that “white lists” remain intact, even in a default situation.
A white list is a list of pre-approved funds that investors are able to sell paper to on a deal. White lists have been getting shorter and more restrictive but until now have always maintained a precedent that they fall away on default, enabling investors to sell to anyone willing to buy the paper.
“Sponsors want white lists to apply in an event of default but this has been universally pushed back on. There are lots of difficult terms being asked for but this one won’t be given,” a second head of leveraged finance said. …GONE? Some bankers are lobbying sponsors, asking them to re-evaluate their stance on transferability, worried that it will put off new inflows to Europe’s leveraged loan market that have been attracted by high yields and low default rates.
Bankers fear much of the new money from insurance companies and pensions funds will leave the market and not return if they get burned on credits they can’t get out of.
“There is a problem, as once the cycle turns and loans become stressed and distressed, investors need to trade out of them. If they can’t, then the issue will be how to attract those investors back to the market once the cycle turns again. I guarantee that when people can’t get out of the assets, they won’t return. Once you scare some marginal investors away, they aren’t coming back. The sponsors, however, don’t want to listen,” a capital markets head said. (Editing by Christopher Mangham and Matthew Davies)