LONDON, April 2 Sponsors are asking banks to provide the first pure European covenant-lite debt package to back a potential buyout of French catering firm Elior, causing concern among bankers and investors that the more risky financing will become a more common fixture of the market.
Covenant-lite financings have been a staple feature of the US market since 2005, peaking at $47.9 billion in the second quarter of 2007 and raising $42.5 billion in the fourth quarter of 2012. Despite large volumes in the US, covenant-lite deals have in the main been shunned by the more conservative European loan market, as bankers and investors have clung to a vast array of financial and maintenance protections.
With the emergence of a greater number of cross-border transactions, covenant-lite hit Europe through euro carve-outs of large dollar financings. Recent examples include French telecoms equipment maker Alcatel-Lucent, UK-based engineering firm Doncasters, call centre company Genesys, Belgian chemicals company Taminco and insulation manufacturer Unifrax.
Sponsors prefer debt without covenants and could turn to the bond market, which has no financial covenants and few maintenance covenants, providing a real threat to loan investors eager to do deals and prevent the departure of well-liked credits from the asset class. The leveraged loan market has suffered as loans exited to the bond market and leveraged loan volume was outstripped in the first quarter of 2013 by the high-yield bond market, where issuance hit an all-time high of $45.5 billion.
"Transatlantic financing deals have broken down barriers and a number of European funds have taken European tranches of covenant-lite deals. Investors can no longer say that Europe does not do covenant-lite," a European loan syndicate head said.
Elior's sale has attracted early interest from buyout firms including BC Partners and CVC Capital, which could team up to make a joint bid. Sponsors have asked if banks will arrange a covenant-lite deal to back the buyout but are also considering asking for the same structure on a number of other potential LBOs in the pipeline, including German energy-metering firm Ista.
"This is a buyers' market as there haven't been too many LBOs this year and cash-rich investors are eager to do deals. Sponsors will push for covenant-lite and if the credit is strong and the debt a good size, then absolutely sponsors will give it a crack and ask whether it can be done," the syndicate head said.
Despite leveraged loan funds becoming increasingly accustomed to covenant-lite deals, they are still cautious of them due to push back from their own investors. When fundraising, one of the strong selling points is that the European loan market still benefits from covenants.
"Investors of the investors could push back as the security of having covenants on deals is a great selling point when fundraising," the syndicate head said.
Bankers also prefer protections in a difficult economic environment. "I wouldn't underwrite a pure covenant-lite deal to euros with no protections. Banks want to be in a loan that looks like a loan and don't want to do anything that requires policy exceptions," a second European loan syndicate head said.
There are compromises that could be introduced that would see some covenants dropped and others retained.
A "covenant-loose" deal could see the removal of fixed charge covenants and free cashflow covenants - two protections that are most under threat in the short term, bankers said. A "covenant-lame" deal has covenants that only kick in when more than 25 percent of a revolver is drawn.
"The way to do it would be to launch with covenants and then rip them out," the second syndicate head said.
The first syndicate head said: "Any bank that goes covenant-lite will need some pretty big balls because it has not been done yet and it will get some resistance." (Editing by Christopher Mangham)