Leveraged Finance Roundtable discussion

Bill Troup, Managing Director, Debt Advisory at Livingstone, chaired a recent roundtable hosted by Livingstone and the law firm Reed Smith, where we gathered together senior figures from banks, direct lending funds and private equity investors to assess the current environment for leveraged finance.

It’s a fascinating time in the market. Since 2008, we have seen the return of the clearing banks. But there has also been a steep increase in the number of alternative lenders, who have raised significant firepower from yield-hungry investors. So as the clearing banks become more aggressive in their structures, the alternative lenders have both the propensity and capability to lend at higher multiples.

We are not at the top of the market, but there are concerns 

Generally, the mood was confident but some concerns were raised about “a wall of money chasing far too few opportunities.”

The most bearish view came from one banker: “whether you are an equity or a debt investor, there is too much money chasing too few deals and it feels like a bit of a bubble,” he said. This is more the case at the upper end of the market, he believed, where some of the terms were “back to 2007.” However, he acknowledged there was one material difference – that, because of the amount of equity liquidity in the market, the size of the equity cheque was holding up.

Others were less convinced. “We have a long way to go before we get back to 2007 levels,” said one private equity GP, “as the economic environment and investor base is very different.”

“We are not at 2007,” said one direct lender, “but maybe we’re at late 2005 or early 2006. It’s a bit toppy.”

“Leverage levels are creeping up slightly but they are dependent on both sector and credit,” said one direct lender.

There’s pressure to put money to work

“The banks clearly want to put their money to work because they are under pressure with portfolios running off,” said one debt fund manager. “Many new debt funds are under pressure to deploy. Those who were fortunate and who raised their funds earlier are under pressure to keep on the pace. We are all working harder to get the money deployed.”

The market has changed. The clearing banks and the debt funds are accommodating each other…

“The liquidity that is necessary in a normal leveraged loans market can’t just be provided by the traditional bank lenders,” said one senior corporate banker, “so we need direct lenders to make the market work.” Referring to recent transactions where credit funds and banks have jointly underwritten unitranche loans, on a first loss, second loss basis, “we are partnering with several of them on transactions. We will co-exist, and the market will develop.”

“Our relationship with banks is that of a classic frenemy,” said one direct lender. “We look at them both as partners and competition although fundamentally, it’s more about being partners. We can co-exist quite easily alongside each other. The debt funds do offer something different – and that is frequently dictated by the client who wants more flexibility and higher leverage.”

…and they need to get to know each other better

One participant described how his bank had already partnered with debt funds on deals, and emphasised the importance of developing an effective working relationship. “We have rehearsed post-deal scenarios with them in order to understand how they would respond if and when things did not go as planned.”

“Rehearsing is one thing, but there are lots of debt funds,” observed one banker, “and it remains to be seen how they will behave when things don’t go as planned.”

Interest rate rises hold no particular fears

“Interest rates are not going to make much of a difference and most of the deals that we see are hedged to a certain extent,” said one corporate banker. “They won’t make a good business suddenly turn bad.”

“Most businesses could withstand some form of rate hike,” said one direct lender. “In our experience, what kills these businesses isn’t an increase in interest rates; it is usually a dynamic within the industry.”

Relationships matter, say the private equity sponsors…

The private equity sponsors said that they wanted to build relationships with debt providers rather than shopping for the best terms on a deal-by-deal basis. That said, one private equity sponsor did recognise that their last UK deal had benefitted from “exceptional pricing.”

“Relationships definitely matter. With any portfolio of investments, there will always be those who hit bumps in the road,” said one GP. “At that point, we want to know that the debt provider will behave as a partner.” It was acknowledged that, given the number of new players in the marketplace, it would be impossible for any private equity sponsor to establish such relationships with them all. Debt Advisors help us with that.”

“We are working with a couple of debt funds at the moment and it is a partnership that can work reasonably well,” said another private equity sponsor. “They are a welcome addition to the market.”

“Innovation within the funding market can only be good for us,” added another.

…as does the risk appetite of the entrepreneur

“The amount of leverage does depend on what the entrepreneur is shopping for,” noted one private equity sponsor. “Some entrepreneurs are more comfortable with leverage and take the least dilutive option; others want a safe balance sheet and prefer an equity-type investment. It’s horses for courses.”

It will take time before some US structures reach Europe

It’s been thought that the US business development companies (BDCs) – that are, effectively, listed direct lending funds – are likely to appear in Europe in the future. However, one direct lender was dubious. “It’s possible but a lot of regulatory change would need to occur. As they are public vehicles, BDCs need to report about the underlying portfolio companies. In the US, sponsors are less concerned about such public disclosure of performance; in Europe, the whole point of a private debt fund is to keep it private. So never say never – but it will be a long time before we see a BDC vehicle in Europe.”

Our thanks to our guests for their contributions to the discussion:
David Wilmot, Joint Head of Mezzanine and Private Equity, Babson Capital Management

Jonathan Seal, Partner, Covenant Capital
Christine Vanden Beukel, Managing Director, Crescent Credit Europe
Chris Fowler, Managing Director, CVC Credit partners
Eleanor Blagborough, Investment Director, ECI Partners
Esteban Abad, Director, Generation Investment Management
Paul Moravek, Partner, Hayfin Capital Management
Alastair Mills, Principal, H.I.G Capital
Ian Crompton, Senior Director and Deputy Head, HSBC Mid-Market Leverage Finance
Stuart Robinson, Partner, Inflexion Private Equity Partners
Anthony Sills, Partner, Langholm Capital
Paul Figgins, Investment Director, LDC
Luke Jones, Partner, MML Capital Partners
Alec Parkinson, Partner, Primary Capital
Richard Roach, Head of Financial Sponsors UK, RBS
Tommy Seddon, Vice President, Origination UK & Ireland, Riverside Europe Partners