Cov-lite deals blossoming in Europe

The European mid-market is taking on a level of deal risk once reserved to the US, a trend some attribute to the growing popularity of private debt funds in the region. 

The number of European deals with a covenant-lite loan package more than doubled in the second quarter, according to Marlborough Partners' Q2 review.

There has been a pronounced trend towards more sponsor-friendly terms in the European mid-market, according to the London-based debt advisory group, following a similar move in the large-cap market.

A typical 'aggressive' mid-market senior bank-derived deal today features non-amortizing debt, higher leverage, tighter pricing, longer-dated maturities, a smaller equity check and other weaker provisions compared to a similar deal in 2013, Marlborough said.

While still a long way behind the US in terms of cov-lite popularity (where 62 percent of loan deals in the first half of 2014 lacked maintenance covenants), Europe nonetheless saw an increase from 6 percent of deals in the S&P European Leveraged Loan Index in H2 2013 to 14 percent in the first half of this year.

Cov-lite issuance of more than €10 billion has already eclipsed the total for the whole of 2007 of €8.1 billion, Marlborough said.  

Even deals which eschew cov-lite structures are still typically 'cov-loose', according to the report, with greater tolerance for refinancing risk also helping to drive up leverage levels.

Private debt funds have made major inroads into the European market, Marlborough noted, creating more competition and providing increasingly flexible capital.

Overall leveraged loan activity in the UK surged in the second quarter, totaling €8.3 billion compared to €1.6 billion in Q1 and €5.3 billion in the same period last year. This was driven in part by several large issuances from the likes of Saga and Virgin Media, the report suggested.

In Europe, high yield volumes reached €51.2 billion the first half, significantly higher than the €39.5 billion of junk bonds issued in H1 2013.

The iTraxx fluctuated between 219 bps and 296 bps during the second quarter, settling at 235 bps – 45 bps lower than the level reached by the end of Q1.

The average spread for institutional loans in the UK maintained its downward trend, reaching 423 bps.

Leveraged buyout activity increased in Europe, with refinancings and recapitalizations accounting for a diminished share of overall dealflow, down by 27 percent from the level reached in Q1 2013. Average leverage in European LBOs rose from 4.7x to 5x in the year to date versus the same period last year, while average senior leverage rose from 4.4x to 4.8x. The average equity contribution remained low at 43.6 percent, Marlborough said, reaching 42 percent on sponsor-to-sponsor deals. This was the lowest proportion of equity since 2007.