One of the most significant themes in European leveraged loans in 2014 was the continued convergence of terms with those seen in the U.S. There are a number of factors behind this convergence, including:
- the trend toward European borrowers issuing debt in the U.S., under New York law with typical U.S. terms, meaning that European investors have been forced to offer increasingly borrower-friendly terms to compete
- the physical movement from the U.S. to Europe of sell-side and buy-side professionals who are familiar with typical U.S. terms, as well as increasing evidence of U.S. buy-side investors investing in European loans
- the relative scarcity of M&A activity, resulting in yield-hungry investors. Whilst 2014 was a record post-crunch year for European leveraged loan volume, there were extreme fluctuations from month to month with a significant drop in issuance from August onward (S&P Capital IQ LCD)
- the willingness of sponsors to use New York law credit documentation even when issuing debt solely in Europe, further enhancing the European buy-side’s familiarity and growing acceptance of those terms
The main areas of convergence to date have included:
- Maintenance Covenants: European leveraged loans have traditionally included three or four maintenance covenants, however, very few of the larger deals of 2014 included more than two covenants and the vast majority were ‘cov-loose’ (i.e., included a single leverage covenant only or a leverage covenant along with a cashflow or interest cover covenant) or ‘cov-lite’ (having the same meaning as in the U.S., i.e., a springing leverage covenant applicable to the revolving credit facility only).
- Equity cure: When curing a leverage breach in Europe, cure proceeds have historically almost exclusively been applied to reduce net debt rather than to increase EBITDA. In 2014 (and also to date in 2015), however, there has been some movement away from this traditional position, with a number of deals benefitting from an EBITDA cure. In Europe, sponsors have generally also won the ability to overcure, even where an EBITDA cure is included.
- Debt incurrence: European leveraged loan documentation has also become increasingly flexible in relation to debt incurrence, with incurrence-based incrementals now the norm for large cap sponsor transactions, alongside a freebie basket and the flexibility to include the new debt as an incremental (within the same documentation as the original loans) or as incremental equivalent debt, outside the original credit documentation. As in the U.S., there is a continuing debate around MFN protection and related sunsets, but in a number of recent deals, 12-18 month sunsets have been won by sponsors alongside 100bps increases for the MFN. It is also unusual for the MFN protection to extend to restrict the pricing for any incremental equivalent debt.
- Restricted Payments: European leveraged loans have expanded the build-up basket concept in line with the U.S. market to give greater flexibility to make restricted payments, and there has also been increasing pressure on the leverage thresholds at which restricted payments can be made. There has even been some limited evidence of a blanket permission to apply the proceeds of any incremental debt toward restricted payments, relying solely on the incurrence based test for raising the debt. Annual freebie baskets, sometimes with a grower, have also been seen for European leveraged loans, in addition to the traditional monitoring fee.
- Acquisitions: permitted acquisition criteria have been eroded significantly on a number of deals. Traditionally, acquisitions under European documentation have been subject to a wide range of different conditions, from financial caps and covenant-based tests to due diligence requirements and jurisdictional limitations. In certain recent deals, these have sometimes been reduced down to a single requirement not to acquire any company or business in a sanctioned jurisdiction.
It has been interesting in the early part of 2015 to see that, whilst convergence was initially driven by (amongst other factors, as highlighted above) European issuers chasing better pricing and greater liquidity in the U.S. debt markets, the tables appear to be turning. A stronger dollar and lower European borrowing costs are attracting U.S. companies to issue debt in Europe. According to Dealogic, to date in 2015, U.S. companies and financial institutions have issued three times as much euro-denominated paper than in the same period last year. These so-called “Reverse Yankee” transactions are likely to lead to even greater alignment of terms between the Europe and the U.S.