RLPC-Pricing differentiation enters Europe's leveraged loan market

LONDON Mon Aug 4, 2014 11:22am EDT

LONDON Aug 4 (Reuters) - Europe's leveraged loan market is experiencing real pricing differentiation where assets are being assessed on credit fundamentals, eroding the standard wholesale pricing model that has defined the market up to now.

A healthy supply/demand balance, a vast amount of liquidity and a recent flood of deals, means credits are clearing with different interest margins and discounts. This has broken the mould of deals reverse-flexing in a quiet market and flexing up in a busy market.

"This is the first time there has been true pricing differentiation in Europe," a senior leveraged loan banker said. "The market is very busy but there is also an enormous amount of liquidity so it has created the perfect storm for the market to behave more maturely. When it got busy previously the entire market repriced irrespective of credit quality. In a quiet market, lower-quality assets would reverse-flex due to demand."

Recognising yield and credit differentials is something that is common in the US market but has escaped the less liquid, less busy European market.

The roughly 25 leveraged loans syndicated in July, coupled with large amounts of liquidity from new CLOs, credit funds and repayments, has prompted the European market to act more like its US counterpart when it comes to pricing risk.

"The European market has been perceived as being junior to the US market for years and this is the first evidence of a more mature European market," the banker said. "Managers have choice and are performing a function by selecting a credit over another credit, which is reflected in the pricing."

GONE DOWN WELL

A number of deals were well-received by the market and reverse-flexed, including those of drug capsule-maker Capsugel, which reduced an interest margin to 275bp from 300bp, and French medical diagnostics company Sebia, which finalised at 325bp at par from initial guidance of 350bp at 99.75.

Other deals did not fare as well. Healthcare firm Independent Clinical Services ended up paying 525bp with 98.5 OID from initial guidance of 450bp. Dutch TV company Endemol's 1.1 billion euro (1.48 billion US dollar) dividend recapitalisation widened spreads to 525bp on a euro first-lien from 475bp and the OID increased to 98 from 99. German plastics maker Styrolution also widened guidance on a euro first-lien to 400bp-425bp from 350bp-375bp, while the OID widened to 99 from 99.5.

Although pricing differentiation is a useful tool, investors doubt whether higher yields can clear some of the trickier assets. They also doubt whether good-quality assets will keep the investor bid if they reverse-flex too tightly.

"There are one or two credits that no one likes so they are cranking up the margin and putting more OID on, such as Styrolution and Endemol," an investor said. "At the other end of the spectrum, people are still being very greedy and trying to be super tight."

TIMING CONSIDERATIONS

A 500 million euro term loan for institutional investors backing an acquisition of healthcare firm Generale de Sante reverse-flexed to 350bp from 375bp. The deal is on a ratchet and pricing could reduce further to 325bp if leverage falls below 3.5x. The reverse-flex led some investors to reduce or withdraw their initial commitments.

"The pricing on Generale de Sante was well below what leveraged investors can do," a second banker said. "Most investors need at least 400bp and this was 350bp with no floor. Given the rating of the company they could do it but it was more one for the banks in the end rather than the real leveraged institutional investors."

Some arrangers began to factor in pricing differentials for deals later in July in an attempt to avoid pricing flexes and to get deals cleared before the summer. Germany-based automotive engineering company Amtek Global Technologies' 275 million euro, five-year Term Loan B launched at 550bp and is expected to carry a 98 OID.

"Amtek is a difficult deal and has all sorts of issues," a second investor said. "The pricing reflects that."

The emergence of healthy pricing differentiation in Europe's leveraged loan market has been welcomed by arrangers and investors but some say its continuation is based on fragile dynamics and could be shortlived if deal flow falls in the fourth quarter.

"Lots of supply and lots of demand have driven the healthy dynamics that emerged in July and who knows if it will last going into the autumn," the first banker said. "The danger is that if the market goes back to a situation where there is a lack of supply, investors will once again have to take credits on terms that they would prefer not to." (1 US dollar = 0.7454 euro) (Editing by Christopher Mangham)

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