Follow Comments Following Comments Unfollow Comments

The European credit markets are set to undergo a shift this year, as private equity sponsors sway back towards the loan product to finance buyouts, sources say. The nuances of the loan product and the perception of a highly liquid loan investor base – coupled with the arrival of cov-lite cross-border loans – means the European loan market will be able to compete with its bond counterpart once again.

High-yield issuance has surged in recent years. allowing it to move out of the loan market’s shadow, helped by the bond-for-loan refinancing juggernaut as sponsors tapped into the liquid, cheap, and cov-lite financing option offered by bonds .

In 2006 and 2007, bonds accounted for just 16% and 17% of the leveraged finance deal count, respectively. That compares to an average of 50% since 2010. Moreover, last year’s bank-to-bond deal count was 62 – nearly twice the next-largest full-year supply of 36, tracked in 2010. In 2010 through 2013, there have been 150 bank-to-bond transactions for a volume of €51 billion, in a sweeping transition of money from one asset class to another unprecedented in the European leveraged market.

Now, not only has the flood of loan-to-bond refinancings slowed, but market players expect loans to move back into favour versus high-yield when it comes to new buyout situations.

In 2013 loan-only financing was used to back just under 60% (by count) of all M&A financings tracked by LCD across the loan and bond markets, while the popular bond-plus-RCF structure took a 14% share. These annual readings are, respectively, the lowest and highest of the past four years.

So far in 2014 through to March 12, although the pattern of deal flow is still taking shape, loan-only M&A financing has grabbed a 77% share of all deals, while the bond-plus-RCF option is yet to appear.

For jumbo M&A situations such as Numericable. arrangers will want to tap both markets, but away from these the appeal of the loan product is evident again. “The huge driver of supply from 2010-13 has been bank-to-bond, but people are now more constructive on the loan market,” says a banker.

For prospective issuers the loan product offers cheaper financing. The 90-day rolling average yield to maturity at issue on secured bonds is 6.35%, versus 4.5% for TLBs as of March 7. Both are at historically tight levels, and while the spread between the two has narrowed over the last three months, the second half of last year saw the spread at 2.75% (it has been higher once, at 3.12% in the first quarter of 2012), which began to entice issuers to look more closely at loans again.

A key development has been a deeper bid for the loan product. The 2007 loan bonanza was fuelled by CLOs but these subsequently fell away, while banks have been reluctant to lend due to tighter regulation. However, the emergence of more managed accounts and a general pick-up in traditional institutional money have ensured there is no longer a dependence on CLOs for the leveraged loan product.

Even so, the re-emergence of the CLO product adds further comfort that the loan bid is deep and strong. The European CLO market is expected to see at least €10 billion of new issuance this year, versus €7.4 billion last year, and essentially zero during the previous post-crisis years.

“There has been a move away from the dependence on CLOs we saw in 2007,” a banker says. “There is now more traditional institutional money raised, and a new breed of CLO.”

The investor base is hungry for supply, and the €2 billion loan from Ziggo last month highlighted how deep the European market has become – albeit it for a double-B credit. “Ziggo has given sponsors a different perspective on what can get done in loans,” says a banker.

Meanwhile, banks are starting to feel underlent, and are therefore looking to add assets, according to sources. The bond-for-loan trade has resulted in a much larger run-off in bank balance sheets than expected or needed, and interest income is down, sources add. Furthermore, weak corporate M&A volumes mean there are limited opportunities for banks to provide term debt that might carry a premium.

The documentation story

Sponsors have often preferred high-yield over loans in recent years due to bonds being a more flexible asset class with fewer covenants and, in more recent years, a willingness to provide portability.