The Banking & Finance 2019 guide provides expert legal commentary on key issues for businesses. The guide covers the important developments in the most significant jurisdictions.
Last Updated: November 12, 2018
2018 was another strong year for the financing markets. Banks, alternative debt providers and institutional lenders all had a significant part to play in this. Whilst European banking and finance is not all about leveraged finance, the leveraged finance market nonetheless remains the most dynamic part of the banking market, with a number of different recognisable themes and trends, as noted below.
High-Water Mark for Convergence
The institutional investor base (and demand for floating rate yield) continues to deepen. Institutional investors’ portfolio approach to investing in loans goes hand in hand with a “capital markets” approach to the origination and distribution of term loans. Investors in European term loans also hold both cross-border term loans with terms and conditions that reflect market practice in the US and high-yield bonds. Together these three types of instruments comprise the universe of financing options available to private equity sponsors raising debt in Europe and the US. An increasing number of private equity firms drive the financing process with a view of getting to the same substantive result on documentary terms for any given portfolio company or acquisition financing. All of this, in turn, has resulted in convergence in terms of European term loans, US term loans and high-yield bonds, to a point where we would say the position in European term loans for top-tier PE sponsored deals is no longer (or at least not appreciably) “more conservative” than US term loans or high-yield bonds.
Capital Structure Options and Flexibility
The past couple of years’ activity, in particular in 2018, has displaced any residual notion that high-yield bonds are an occasional product or that this component of the market is fickle. Regardless of how deals ultimately get done, a very substantial portion of the large new deals in 2018 have looked – from the outset, ie, at the time banks first “pitch” the financing solution to PE firms – to both an “all loan” or a “bank/bond” capital structure. For upper mid-cap and large-cap deals, these capital structures comprise senior and second lien secured loans, senior secured loans and junior (unsecured) high-yield bonds or senior secured loans, senior secured bonds and junior (unsecured) high-yield bonds. At the smaller end of the scale, we increasingly see sponsors selecting between “all-senior bank” deals and “unitranche” financings (as to which see below), for the same financing. Needless to say, whatever the day-one capital structure documentation for the syndicated or non-unitranche financings, the documentary architecture day one permits sponsors to plug in different types of debt. As a result, a credit that may today be a “loan only” issuer in the market could subsequently be both a loan and bond issuer or only a bond issuer, and vice versa. This is a further reason for convergence across terms and conditions, aimed at ensuring the sponsor does not end up with materially different terms and conditions solely due to the choice over time as to the type of instrument (loan (whether European loan or US) or bond).
With the depth of the US leveraged finance market and strength of demand from investors in it, 2018 saw no dearth of cross-border transatlantic financings for European or predominantly European companies. The debt for these deals is distributed in both the US and European markets, typically, comprising USD and/or EUR/GBP tranches. The documentary terms and conditions of these deals are almost entirely reflective of the terms of the US leveraged finance market, albeit with underlying differences in corporate structure and legal regimes resulting in modifications to the entirely domestic US terms and conditions to produce a well-defined, cross-border or transatlantic suite of documentation that is rather different in form (but not so much when it comes to substance any more) from the “all European” suite of documentation. Notwithstanding the difference in forms, convergence in terms results in the substantive terms being very similar indeed, leaving aside more subtle differences or divergence resulting from a difference in the underlying form or historical approach in one or other financing markets. Needless to say, and not unsurprisingly, it is the US term-loan market that has been influencing and continues to influence the terms of European term loans, and not the other way round.
Transformation of the Direct Lending Market
For a number of years, commentators and market participants have observed the rise in provision of financing by private credit funds on a bilateral or club basis, as an alternative to the bank/term loan and high-yield bond products. The number of credit funds which compete directly with banks to underwrite deals directly, whether in full or together with another credit fund and whether for the entire capital structure or part (eg second lien/junior debt) continues to rise. Whilst this is noteworthy it should not be mistaken for a real shift in the way in which most deals get financed. Executed deal volumes are much, much greater in the syndicated or capital markets. In previous years it was fair to say that the terms of the deals done by such funds were much more conservative than the alternative financing sources available to private equity firms and companies in Europe. 2018, however, represents a high-water mark for documentation in this space from a qualitative perspective, in that the terms and conditions executed on such transactions moved closer in a meaningful way to the terms in the large cap syndicated or even high-yield bond markets. This is not to say they are one and the same; they are not, and meaningful differences remain, given the difference in underlying investment philosophy between such credit funds on the one hand and institutional/CLO investors on the other. This is not a homogeneous market. These funds operate across a spectrum in a notable way – with investment philosophy and approach to documentation differing across them.
2018 was an exciting year for European leveraged finance due to a number of inter-related factors: convergence, cross-border deals, substantial shifts in approach to direct lending transactions, etc. For completeness it is worth noting that banking and finance in Europe also encompasses traditional bank lending, whether pursuant to syndicated or club deals, and whether investment grade or not, and that a notable part of this market relates to “infrastructure” acquisition financings and refinancings, the core principles of which are similar to those of leveraged finance but also different in notable respects, given the absence of a CLO or institutional lender base.
Having said all this, clients in Europe have a range of options available to them when it comes to obtaining legal advice to structure and execute their deals: substantial teams that offer the full range of capital structure solutions with equal strength and depth across these; firms that major on certain aspects of the market – whether product, size or type of instrument; whether lender-focused or issuer-focused; firms that are stronger in Europe than they are in the US, and so forth. As the financing landscape continues to change and to be influenced by the US-leveraged finance market and high-yield bond terms, we anticipate not only clients participating in the largest deals but also those in the mid-cap space will increasingly wish to have access to law firms and, in particular, individual lawyers who have breadth of perspective and depth of expertise across a range of instruments, techniques and markets, depending on the needs of the client.