Q3 2013 Market Update

Marlborough Partners, the independent leveraged debt advisory firm, today published its report on the leveraged finance market for private equity primary transactions and portfolio company refinancings in Q3 2013.

The quarterly snapshot, analysing data from a number of sources shows that, whereas across Europe as a whole loan volumes fell to €14.5bn from €24bn in Q2 (largely due to the August slowdown in many continental countries), in the UK alone, loan volumes remained healthy at €4.5bn, similar to the €4.7bn in Q2 and significantly above the €1.2bn in Q3 2012.  In the first three quarters, loan volumes for UK deals were €11.9bn, compared with €5.5bn in the same period last year.

Despite the summer blip, market conditions for LBOs across Europe remained buoyant, with average senior and total leverage levels reaching 4.4x and 4.7x respectively. Average equity contributions fell to 41.7%, the lowest level since 2007.

Dividend recapitalisation loan volumes for the year to September 30th reached a higher level than at any time since 2007 at €3.3bn, with a further €4.6bn raised through bonds, resulting in €5.3bn of dividends being paid out to GP-managed funds.  This resulted in GPs being able to return 46% of the original equity input to investments an average of 3.4 years after those investments were made.

Refinancings and dividend recapitalisation loan volumes accounted for 49% of European private equity loans in the year to September 30th, as opposed to 46% for primary investments. This is the first time the European leverage loan market has seen this and highlights the lack of primary deal flow witnessed in Europe year-to-date.

The iTraxx Europe Cross-Over index, a key indicator of pricing expectations for sub-investment grade risk, steadily tightened to under 400bps having been at over 500bps at the end of Q2. European high yield issuance continued its upward movement, reaching €54.9bn in the year to date, which is a record figure for the first nine months of a year.

The report also looks at US-European cross-border lending, which has risen to €19.2bn in the year to September 30th, compared with €6.5bn for the whole of 2012.

These transactions are becoming increasing prominent in larger European private equity deals, with GPs taking advantage of more borrower-friendly terms in the US, a breadth of available liquidity and better pricing.   Leverage-equity ratios on US financing are also attractive, with the average leverage for cross-border deals in the year to September 30th standing at 5.2x and average equity contribution at 30%, compared with averages of 4.7x and 42% respectively for European-financed buyouts. Cov-lite loans are more typical in US financings; most US-Europe cross-border LBOs to date this year have been structured in this way.

In Marlborough’s view, successful financing from the US for European deals is dependent on those deals being large enough to be financially liquid both sides of the Atlantic, with – in most cases – the company being financed generating a proportion of its revenues in the US.  Furthermore, the financing raised should ideally mirror the currencies of the company’s cash flow, thus avoiding expensive foreign exchange issues.

Marlborough Partner, Markus Ehrler, comments: “This quarter shows two related trends: a continuing increase in dividend recapitalisations and competitive pressure from US sources of capital on European lenders.

“Although dividend recapitalisations attracted negative publicity in the run up to the financial crisis, most of the companies now recapitalising have survived the most difficult three or four years that many have ever experienced and will therefore be pretty robust businesses, capable of servicing higher levels of debt.  Furthermore, average debt-equity ratios, while creeping up, are still nowhere near the average ratio seen at the top of the market in 2007 of 66%/34%.  Nevertheless, it is important for all of us to keep an eye on the sustainability of this model.

“The US financing market is attracting many European issuers and we expect more companies of appropriate size to follow, despite the current political tensions within the US.  One possible consequence of this competition may be European lenders entertaining looser covenants – something that will delight many GPs.”

Marlborough’s recent transactions include the refinancing of Exponent-owned Trainline and Equistone’s acquisition of Whitworths.

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