RLPC-European leveraged loans face big changes to take on US might

LONDON, June 3 Mon Jun 3, 2013 12:12pm EDT

LONDON, June 3 (Reuters) - Europe's leveraged loan bankers and investors will have to be more flexible, adaptable and prepared to take risks in order to stem the increasing flow of traditional European loan borrowers that are choosing to tap the US leveraged loan and European high-yield bond markets.

More European borrowers are financing deals in the US and high-yield markets, lured by fewer covenants, higher leverage and greater liquidity than European loans can offer. Transferability and documentation also remain major stumbling blocks and an apparent unwillingness to adapt is making Europe's leveraged loan market uncompetitive, bankers said.

"If the US loan market can do something, it does beg the question why the European loan market can't do it as well. Right now companies are prepared to go to the US rather than the European market, which is their natural home," a syndicate head said.

"European banks and investors are not as open as the US. It is all very well having credit standards, but if those standards mean Europe is not making investments and paying the bills, then something is not working."

Technical conditions in the European loan market are seeing demand far outweigh limited supply. In order to attract decreasing deal flow, banks need to become more aggressive to keep up with the competition.

"Banks are going to have to become more malleable and those that keep doing what they used to do when there was not a lot of liquidity won't work anymore. The survivors will be those that adapt and are flexible," a capital markets participant said.

COV-LITE ATTRACTION

One big difference between the US and European leveraged loan markets is the US market's willingness to provide covenant-lite structures. This has lured European companies such as French animal identification company Allflex, German insulation firm Armacell and German industrial ceramics firm CeramTec to the US loan market.

In a bid to keep deals in Europe, lenders recently agreed a covenant-loose structure for the buyout of German metering firm Ista, but the dual-covenant structure still falls short of what is offered more readily in the US.

Even if Europe provides covenant-lite loans, euro-denominated loans are still pricing wider than dollars. Allflex decided against a euro carve-out because a US deal was still cheaper, even taking swap costs into account.

Europe needs to accommodate more aggressively-priced risk for top companies to stay competitive. Sponsors want a bigger pricing range, based on an individual credit's attributes rather than one driven by market convention or consensus.

"If Europeans want to compete, they will need to get more aggressive on pricing risk and act like the US, where a credit can price at 275 bps and another at 600 bps on the same day," a leveraged finance banker said. Some European banks, including HSBC, have tried to expand their

US presence by stepping up headcount and resources, but it is difficult to make an impact in an established market where the role of lead left is dominated by around five banks. "Developing or expanding a practice area takes time to build the relevant experience and credibility," a second leveraged banker said.

The European loan market has been overbanked for some time and one outcome could be for some banks on the fringes of activity and unwilling to invest in their operations to close down their leveraged loan desks.

NEED TO ADAPT

Those banks struggling for market share that are determined to continue to offer a leveraged loan capability will need to adapt their business models to increase their competitive edge.

For those that have not done so already, one way would be to build a high-yield bond presence to capture more deals.

Lloyds began to focus on high-yield 18 months ago. In 2011 it was ranked 22 on Thomson Reuters' European high-yield bookrunner league table with 0.9 percent of market share, increasing its position to 19 in 2012 with 1.2 percent market share. In 2013 to date, the bank has risen to number 16 on the table with a 2.1 percent market share. Nomura made the top 25 on the bookrunner league table in 2013, its first appearance since 2009.

"There is a propensity to go down the high-yield route, because companies that have lived through a very difficult period would now rather not have to deal with covenants or lenders," the capital markets source said.

The high-yield bond market has proved more adaptable than the European leveraged loan market to date and has met the demand for floating-rate product with an increase in FRNs. The European loan market is expensive and unwieldy in comparison, and borrowers now want to see innovation for new, exciting and competitive structures.

"The European loan market has to adjust its business model and find out how it can influence the market and have a meaningful impact. It is down to them. The best way to influence a market is to take a risk. The words flex and reverse flex didn't exist in the early 2000s: now everyone knows them," the capital markets source said. (Editing by Christopher Mangham)

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