LONDON, June 23 Europe's leveraged loan market has been boosted by the growth in popularity of second-lien loans, as borrowers' reliance on the high yield bond market lessens.
Despite a strong presence in the US, second-lien loans have been few and far between in Europe since the onset of the financial crisis - but have made a return in recent financings including Dutch TV production company Endemol, German packaging group Mauser, Spanish olive oil bottler Deoleo, UK-based TV show producer All3Media and Germany-based heat exchanger company Alstom Auxiliary Components.
"A lot of deals in the market that have a first-lien, second-lien structure would previously have been a mixture of senior debt and subordinated bonds. The loan market dynamic is changing," a banker source said.
The supply/demand imbalance in Europe's leveraged loan market has created an excess of liquidity that investors are eager to put to work. Keen to keep product in the loan market rather than see borrowers tap the high-yield bond market, European investors conceded to covenant-lite deals and are now gaining appetite for second-lien loans, which offer better yield than tightening first-lien paper.
Borrowers are receptive to second liens, attracted by less restrictive call periods compared with high-yield bonds. Banks, competing against each other for deals, are now eager to underwrite second-lien loans, which offer sponsors the ability to put a smaller equity cheque in a deal and achieve higher leverage levels.
A number of bankers are putting together first-lien and second-lien debt financings for sponsors bidding for companies in auction phases, such as restaurant chain Pizza Express and the Co-operative Group's pharmacy business. Bankers would previously have offered a loan and bond structure.
"A particular draw of high-yield bonds over loans was the lack of covenants and tests. If the loan market is offering covenant-lite and second liens, it is no wonder borrowers are taking advantage and opting to raise loans. If you invest in a company that has strong cashflows and the plan is to refinance or take a dividend in the next few years, second-lien is now a no-brainer," a banker said.
Banks are feeling more confident about underwriting second liens as there is an increasing number of investors to sell this to, including CLOs and mezzanine investors that have been starved of paper. In addition, some accounts that have traditionally invested in fixed income are also interested in second-lien loans, as they seek to diversify into floating-rate products with potential interest rate rises on the horizon.
"Given where leverage is going, it is good to have people wanting to buy second-lien and it still offers yield versus senior paper. From an arranger's point of view, second-lien is attractive because you can target CLO investors as well as the mezzanine guys and other interested investors, so there is diversity," a second banker said. (Editing by Christopher Mangham)