The European leveraged loan market has welcomed the launch of a new cross-border loan refinancing from Nielsen Finance Co. after quietly hosting a short-dated term loan for BCA Marketplace PLC, but it is still some way off from a return to widespread issuance, after pulling down the shutters in response to the COVID-19 pandemic.

Demand remains robust though, and many market participants expect conditions to be strong once there is a full reopening.

However, it is still unclear how long they will have to wait until the market comes back to full capacity, and while some fear issuance will be dampened going into the second half of the year, others are more constructive.

“The focus to date has been on liquidity, but now we're turning to earnings,” said one investor. “The reports coming through now are for the first quarter, where we won't really see any impact, so people may want to wait for Q2 earnings reports in three months' time before they start looking at things seriously.”

Even at the height of the global financial crisis in 2009 — when only €15.44 billion of loan volume was reported across the entire year — there was still no full quarter without any issuance in the European primary loan market. BCA's €67 million, three-year term loan that was quietly syndicated to existing institutional lenders in principle ensured that same track record remains the case this year amid the current crisis, but that deal's diminutive size, tenor, and the fact it was only taken down by current lenders makes it an outlier. This week's cross-border term loan from Nielsen Finance, though (launched May 5) — which includes a $300 million-equivalent tranche denominated in euros — offers more hope of a wider reopen.

Long-term plan
With downgrades now coming thick and fast, and with no potential end to the economic challenges caused by the lockdown in sight, market participants are bracing for long-term pain.

“We were modelling for this lockdown to last a couple of months, and asking whether our portfolio companies can cope with restricted cash flow for a fairly short amount of time,” said one investor. “Some are now suggesting we could have social distancing until the end of the year. Nobody has a crystal ball, and nobody knows how long this could go on for.”

Others agree that the current crisis may drag on. “People had been talking about whether the recovery would be 'V'- or 'U'-shaped, but actually I think it will be more like a 'W'-shaped recovery,” said a senior market participant. “We are likely to see some weakness for a while.”

Meanwhile, the ongoing economic impact of the global pandemic and lockdown is still being felt in the secondary loan market. While that market has recovered from its widest point seen in March, at the end of April the average discounted spread on first-lien facilities in the S&P European Leveraged Loan Index (ELLI) was higher than at any other point over the last seven years, at E+655.

As of April 30, some 37% of the ELLI was still priced at 89 or below.

With such an unstable backdrop, participants note issuers may have to pay a sizable premium to access the market, with some suggesting that anything new could carry margins with a 'five-handle.' Note, Verisure Holding AB (publ) reopened the high-yield bond primary market with five-year floating-rate notes (FRNs) at E+500, and is considered to be a strong credit that is less impacted by COVID-19 than most. Unless companies are under pressure to issue, many will likely take time to get used to the new pricing dynamic.

Currently, there is little pressure for many borrowers to launch syndicated loan deals. While there is a pipeline of underwritten transactions, most lenders are happy to wait until the issuance backdrop improves, while there are few deals maturing in the coming few years that could encourage borrowers to bring refinancings.

Market participants also note that for most companies, capex projects have been shelved, and firms are running with fewer cash requirements. “All names are in daylight savings mode, and are being very efficient in terms of cash flow,” said one senior market participant. “Once everywhere reopens, we may see more requirements and more issuers trying to come back to the market, but even then I think they’re more likely to be in the bond market.”

But borrowers in Europe do not only have the newly reopened European bond market to turn to for capital. Sponsors have proved supportive to many of their portfolio assets, while direct lenders are knocking on many issuers' doors, offering to provide financing — at a price. The European market is also famously overbanked, with some lenders providing new and extended revolving credit facilities, while government bailout schemes are expected to help many firms.

“For European issuers, the first call is to the banks, and then they’ll see what help the government can offer,” notes one senior banker. “For many, the capital markets are a last resort.”

The road ahead
To set the scene for future issuance, the loan market had been closed since GERFLOR SAS allocated an €850 million term loan back at the beginning of March, and if it had not been for the small deal from BCA, April would have been the first month with no institutional loan issuance since March 2009 (not including the holiday-impacted months of August and December).

BCA offers a little insight into what the wider market might look at when it reopens, as the borrower sold debt at E+500 (issue price not disclosed), and the paper carries one year of call protection. Nielsen's euro portion of its refinancing is talked at E+400, and 12 months of soft-call protection. This borrower is rated BB/Ba3, while its senior debt is rated BBB–/Ba1, meaning it is not a single-B benchmark, but it too points to wider pricing for those higher up the ratings ladder. This is despite the fact that collateralized loan obligation (CLO) vehicles are trying to mend broken WARF tests, meaning a double-B with a decent OID may well be gold dust for that market. A WARF test measures the weighted average ratings factor of a CLO.

Meanwhile, the bond market has tentatively reopened, with three European transactions from Verisure, Merlin Entertainments (Dungeons) Ltd., and Netflix Inc. emerging over the past three weeks. The five-year (non-call one) FRNs from security firm Verisure perhaps offer the most relevant comparable for the loan market, coming with a coupon of E+500 at 99.5, having been upsized by €50 million in syndication.

Before the COVID-19 crisis hit, European loans and bonds were pricing almost on top of one another.

Corona clause
The latest European high-yield bond from Merlin saw the inclusion of a new 'corona clause' feature, which means that until (and including) the 120th day after the issue date, up to 40% of the aggregate principal amount of notes may be redeemed by the net proceeds of any amount received (pursuant to a regulatory debt facility). Market participants expect any new leveraged loans in Europe to contain similar features, while there could be a change in attitude toward the stringency of documentation on such transactions.

The new FRNs from Verisure also come with an investor-friendly first-call at 102 (rather than the market standard 101), and syndicate bankers suggest investors could push for bond-style hard calls on new loan transactions, as also seen on BCA.

“We will see a shift in power because of the changing balance of supply and demand,” said one investor. “Covenant-lite came in because issuers held the upper hand when there were more investors than issuers. If demand falls, then that could shift back, and we could see better documentation coming for investors.”

Others agree that once the primary market reopens, the balance of power between the two sides of the market could have changed. “Investors will push back now in the same way that sponsors did before,” said one senior market participant. “They will push for what they want. The early deals that reopen the market will become very tight on the documentation, and then we just have to see how long that lasts for.”

CLO demand
However, it already seems that demand in the market may not have dwindled sufficiently to impact the supply/demand dynamic, and participants are pointing to the pricing of new CLOs as the green shoots of recovery for the buyside. Given CLOs have already faced downgrades on parts of their portfolios, they will be looking to restock, especially with well-rated paper — although BB-rated names are still more likely to turn to the bond market to raise capital. While demand from CLOs should be sustained after the crisis is over, sources note portfolio managers are unlikely to be focused on new opportunities currently.

“CLOs have enough problems of their own combing through their portfolios, dealing with downgrade after downgrade,” said one source. “They will be micro-managing every bit of paper they own, so they may not have time for new business at the moment.”

Syndicating banks have already reported they have received reverse-inquiries from the buyside seeking new paper, while large-scale investors are not taking a fundamental step away from the leveraged loan product. While the full reopen might not come for a while, the market may prove strong when it does return.

“We've not seen huge redemptions out of loans,” said one senior banker. “The worst could take weeks or months to come to light, but once the market settles and finds a level, I’m not sure investors will look to redeploy their assets elsewhere. There's still a huge amount of cash out there, and the market could bounce back very quickly.”

This article was written by Nina Flitman, who covers European leveraged finance for LCD.

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