Article 6.4 Loan terms eased in search for yield

By Anne-Sylvaine Chassany

Financial Times March 23, 2014

Ceva Sante Animale, a veterinary drug producer based in France's Saint-Emilion wine region, is tapping into increasingly generous credit markets.

A group of banks including Goldman Sachs and Nomura have agreed to lend nearly ˆ1bn to the private equity-backed company without requesting the typical creditor protections attached to highly indebted borrowers. It is one of the largest ‘covenant light' financings arranged for a European company this year.

The loan package, which the banks are marketing on both sides of the Atlantic, highlights the way that credit markets have become more accommodating of European companies, as institutional investors snap up riskier debt securities and abandon protective clauses in their hunt for yields.

European private equity-backed companies have mostly tapped US investors for loans rather than their region's investors, who have historically demonstrated a greater resistance to ‘cov-lite' loans.

But volumes are also picking up in the region. Nearly ˆ8bn in euro-denominated loans of this type were issued last year. Dollar-denominated covenant light loans to US and European companies reached a record $260bn in 2013, or 57% of the total volume, and 69% more than in 2007.

‘Covenants are being dropped, lenders' arranging fees are going down, interest margins are going down, the amount of debt you can borrow is going up - it's a great time to be a borrower,' says William Allen, a partner at Marlborough, London-based debt adviser. ‘There simply isn't enough paper to satisfy investors' demand and European investors wanting to invest in European loans are having to accept increasingly loose terms.'

Ceva's financing, which will comprise a euro tranche and a dollar tranche, has features that became common at the peak of the credit bubble in 2007.

It will not have to pay down any principal amount before the very end, and will be able to roll over interest payments into debt instead of paying them for about a quarter of the package (in a so-called ‘payment in kind' debt). ‘It's a dream for Ceva,' a person close to the deal said.

It's not a dream for the debt holders, however, according to Jon Moulton, the British veteran private equity executive. ‘Cov-lites are pretty dangerous pieces of paper for those who advance the loan.'

Ceva's creditors will not be able to request a debt restructuring or a cash injection from the company's shareholders in case its creditworthiness deteriorates. This is despite the fact that Ceva's total debt will equal up to 7.5 times its earnings before interest, tax, depreciation and amortisation, a level reminiscent of the leveraged buyout boom.

Buoyant credit markets are also translating into higher amounts of debt in LBOs, which have increased in Europe and in the US to near the 2007 all time highs of six times ebitda on average, according to S&P.

While the Bank of England and the European Central Bank have not yet raised the alarm, they are starting to take an interest in the matter, in the wake of the US regulators, including the Federal Reserve, being concerned about ‘deteriorating underwriting practices'.

‘Private equity is its own worst enemy when it comes to leverage,' said Neil MacDougall, managing partner of Silverfleet, a London-based private equity group. ‘As an industry, we'll just use it to maximise prices.'

FT

Source: Chassany, A.-S. (2014) Loan terms eased in search for yield, Financial Times, 23 March.

2013-2014 when investment-grade debt gave very low interest rates. PIKs can give yields in double figures, but that ‘yield' may be in the form of more bonds - see Article 6.5.