The LMA Early Evening Seminar at Hogan Lovells Amsterdam on 1 October 2019 explored some trends in the leveraged finance market, with reports of a very healthy Dutch market, notwithstanding effects of Brexit, recession indicators in some European economies, trade wars and ECB interventions.
The panel, chaired by Hogan Lovells partner Wouter Jongen, reflected on a good pipeline for rest of 2019, increased competition due to ample liquidity, rising market share of debt funds, loosening of documentary terms and predictions for 2020.
Competition due to excess liquidity
Whilst 'top of the market' predictions have been ongoing for the last 18 to 24 months, the ground reality is more optimistic. Leading sponsors in the Dutch market have lenders lining up to finance their deals.
This flush of liquidity has helped with the upkeep of good sentiments, but has increased competition for lenders where the same assets are being chased by ever deeper pockets. Given the choice now available to sponsors, an important differentiator has become existing 'relationships'. Sponsors are not looking to drive their return on the basis of marginally better pricing, but for flexibility from funds who are willing to finance buy and build strategies and faith that debt funds will be reasonable should the investment go sour.
Increased competition is giving way to continued loosening of documentary terms where sponsors are able to extract various EBITDA adjustments, a particularly from debt funds. Dutch banks are typically seen as more conservative in this respect.
A possible fightback for lenders is to resist transferability restrictions, which would be their most likely exit scenario should an investment become distressed. During a distress period, dealing with an industry competitor or a loan-to-own fund may be a distraction too far for sponsors, and this is broadly accepted by most banks and debt funds alike, but in an age of cov-lite terms and EBITDA adjustments, transferability provisions will continue to become more of an area of focus over the coming months.
What to do when financials weaken
When things are not going smoothly a delicate balance has to be maintained between responding to lender requests for information and the sponsor needing to stay ahead of the narrative by providing solutions with business plans and forecasts. A good solution should include a proactive all-stakeholder analysis, of which lenders are only a part.
The initial rush to have conversations without potential solutions is likely to backfire. At the same time, coordination with lenders should not be delayed till the 11th hour, when the bucket of goodwill has likely all but dried out. Timing therefore remains critical, but good solutions are equally important.
Banks are losing market share to debt funds
Banks are fighting an uphill battle for market share against debt funds that don't have to deal with provisioning and regulatory pressure. A strategic stumbling block is the deal size which a bank is able to fund on its own. Sponsors are unlikely to go for club deals with multiple banks when one debt fund is willing to finance the entire acquisition (and pricing is not substantially higher than bank funding). Turnaround times and flexibility in processes were also identified as key reasons why debt funds win mandates.
With a forecast of bank liquidity tightening in 2020 and debt funds looking to lend at lower pricing to compete with banks, the market share of debt funds is likely to continue rising in the near future.
Dutch banks are more and more looking at alternative products like hedging and foreign exchange to shore up business in areas where they can use their clout of better pricing.
The collaboration between debt funds and banks in the European market was explored in greater detail in one of the panels at the Hogan Lovells FIS Summit in London earlier this year.
2020: what lies ahead?
There was overall optimism on deal flow in the Dutch market, with the following predictions:
- Binary reception of credit: liquidity may have increased competition, but funds will have a heightened level of credit selection as they do not want to provide credit for sub-par assets even with mounting pressure to do deals. On the other hand, if an asset is financeable, funds are likely to go 'the extra mile'.
- Funds will differentiate and try to find niche areas: funds will focus on specific sectors and build upon existing relationships with sponsors, as it will be ever harder to compete only on pricing.
- TLB market will look to mirror the US high yield bond market: documentary terms from the US have regularly found their way into Dutch transactions, and this trend is poised to continue.
- Dutch mid-market leveraged financings are more competitive than ever, however the quality of assets is now becoming an issue, as prices are going up and high EV multiples are a reality.
- The Dutch market remains optimistic, however global chill winds related to Brexit or trade wars will undoubtedly have an impact.
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