The European LBO market had been fairly relaxed about its refinancing requirements before this summer. All that has now changed. "There is a meaningful chance that the refinancing blast in 2015 will be just horrible," said turnaround specialist and Better Capital chairman Jon Moulton at a recent seminar. "The firms that have not yet refinanced will be the ones that will find it hardest to refinance – there is a survivorship bias."
According to rating agency Moody’s, €181 billion of European LBO debt falls due by 2015, with €11 billion due in 2012 and €36 billion in 2013. Initial concern over the impact of this requirement had been recently mitigated by the volume of leveraged loans being refinanced in the high-yield market. But after $15 billion of withdrawals from European high-yield funds in August and just one high-yield trade closed between July and late September this market has screeched to a halt. If it does not return, the refinancing options open to those firms that face maturities in the next few years are drastically reduced.
No return
One option that is highly unlikely to be there is the CLO. Although new CLOs have been written in the US the arbitrage [the difference between the asset spread and the liability spread] that drove the market in Europe is no longer there. "The market cannot rely on the return of CLOs ahead of the refinancing wave [in 2014]," says Clayton Perry, chief operating officer at credit investor Avoca Capital in London. "The problem is that the arbitrage has completely reversed. There is relatively more demand for leveraged loans than there is for triple-A securities because bank term-funding costs have shot up."
 |
|
| "No one has come up with an alternative vehicle that is as efficient as a CLO" |
Existing CLOs in Europe will reach the end of their reinvestment periods before the refinancing wall has been tackled, which will render them unable to purchase new loans (98.6% of European CLOs will begin deleveraging by the end of 2014). Recent research from Standard & Poor’s points out that by 2015, €69 billion of European CLOs will have hit the end of their reinvestment periods while at the same time €61 billion of European leveraged loans held by CLOs will need to be refinanced.
What the market needs is an alternative. "No one has come up with an alternative vehicle that is as efficient as a CLO," says Perry. "It is the leverage – with €50 million equity you can get €500 million of lending."
Any new structure will have to be attractive to institutional buyers. "The market needs to attract pension funds that buy in chunks of €50 million to €100 million rather than €5 million," says Perry. "That may require some changes to the structure of the loan market including liquidity and settlement."
But no matter how much capital can be attracted to the loan market from pension funds and insurance companies it will not match the volume of investment that CLOs provided. This will reverberate not only on the refinancing wall but also on the volumes of new buyout activity. Sponsors have become reliant on high yield to get deals done and if the market does not recover in size they will be constrained.
"The right capital structure exists for every business out there – the key thing is finding it," said Hugh Briggs, managing director at CVC Capital Partners at the recent meeting. "Deal structures have seen a high preponderance of high yield – this has sometimes been appropriate and sometimes been a necessity."
But it has been neither since the market froze. There were $4.8 billion equivalent of high-yield bonds placed in Europe in the second quarter of 2011 after $26 billion were placed in the first quarter. By late September only one high-yield deal had been completed in Europe since the summer – for double-B rated Fresenius Medical Care. The firm paid a 6.5% coupon on €684 million of seven-year unsecured notes. By the end of the month there was talk that double-B rated HeidelbergCement was looking for €300 million through BNP Paribas, Banca Imi, Citi, Deutsche Bank, ING, LBBW, Mediobanca and Royal Bank of Scotland. But the mood in the market is very different from the ebullience of early 2011.
"There is a reversion from the first half of the year," mused one sponsor ruefully in September. "Deals that were perfectly sensible eight weeks ago – people are now looking at them and saying ‘How the fuck did we manage to lever it up that much?’"
Private bonds
The dearth of high yield has led sponsors to consider the private bond market. "We have had a number of recent conversations about private bonds," revealed Matthew Sabben-Clare, partner at Cinven, at the seminar. "They would be executed privately like mezz and be done as a club deal. They can include call protection and equity co-investment but they are neither fish nor fowl. Some mezz funds and hedge funds are exploring this."
Private bonds were recently used in the $2.8 billion buyout of US retailer BJs Wholesale by Leonard Green & Partners and CVC Capital Partners. But some in Europe remain sceptical. "We have looked at this a couple of times but decided not to pursue it," said one sponsor. "We couldn’t find a common ground between loan documentation and high-yield documentation and the pricing quoted was always outrageously high. We would be keen to see this market evolving but haven’t seen it so far."
