October 25, 2019 / 2:19 PM / a month ago

Transfer restrictions concern loan investors

LONDON, Oct 25 (LPC) - European leveraged loan borrowers have attempted to place tougher transfer restrictions on how much investors can trade in portfolio companies, in a bid to curb liquidity.

Transferability has become a battleground for private equity sponsors pushing to strengthen control over their assets in recent years amid the imbalance of supply and demand in the leveraged loan market.

Sponsors have already gained a greater control over which investors can hold and access loans in their portfolio firms, but are aiming to go further as they are now trying to introduce higher transfer thresholds.

The £2.193bn-equivalent loan backing the buyout of UK theme park and attraction operator Merlin Entertainments, which closed this month, surprised the market as it proposed to set a minimum amount of €5m that lenders and investors could trade, compared with a usual €1m-€2m. There was also a minimum hold level of €10m requested on the loan.

The “lock-up” feature faced push back from investors and was scrapped, while the minimum hold and transfer threshold remained at the €1m standard level.

“These terms will not fly. Investors in Europe won’t allow it. Nobody likes it,” said an investor.

However, investors worry the win won’t deter sponsors to keep trying, especially for solid jumbo deals with high investor demand. And with a short comment lead time on documents, investors sometimes might not even notice these aggressive terms in the hundreds pages of documents.

“We are just given 24 hours to review the documentation, and these terms are just buried there,” a second investor who looked in Merlin deal said. “I might miss that in next deal.”

CHERRY PICKING

Investors argue that the suppressing of transferability should not co-exist with a covenant-lite structure because they would get trapped in credits with low investor protection and limited offload options if things turn sour.

“The middle ground supposedly agreed a couple years ago in the syndicated loan market was towards covenant-lite, but at least you can get out from credits you don’t like easier. That’s how you got into covenant-lite,” said the second investor. “But now, sponsors want the best of everything.”

Loans have taken covenant-lite features from high-yield bond market and now more than 80% of leveraged loans are covenant-lite.

“Sponsors are cherry picking, choosing the best of both worlds - loan transfer restrictions and bond covenant-lite flexibility at the same time,” said a lawyer.

To fend off funds having too much influence over portfolio companies, sponsors started to place more restrictions a few years ago by creating a “white list” - a list of pre-approved funds that investors are able to sell paper to on a deal. Hedge funds that tend to take an aggressive approach are often excluded from the list.

In addition language around defaults has also narrowed. In the majority of loans, a default can only be triggered by a major event such as payment or insolvency, which is the late stage of a liquidity issue, compared to any event of default few years ago.

In some cases, white lists are enforced even after a company default, or investors are barred from transferring debt to funds with a distressed background. However, distressed funds are likely to be willing to take the position in difficult circumstances.

“It would end up in a situation that people in there don’t want to be in there and people sitting outside can’t come in. You might have wrong people in a wrong place,” said another lawyer.

In those scenarios, sponsors could step in: “Sponsors may consent it. But it means all will be under control of sponsors,” the lawyer said. (Editing by Christopher Mangham)

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