May 11, 2018 / 3:27 PM / a year ago

Debt underwriters reject deals as documentation erodes

LONDON, May 11(IFR/LPC) - European leveraged finance bankers are turning down opportunities to underwrite buyout deals as they are increasingly concerned by the aggressive lending documents demanded by private equity firms.

Sponsors are still pushing for aggressive terms on leveraged loans and high-yield bonds, which have already been repeatedly rejected by investors, despite weaker market conditions.

With billions of euros of leveraged buyout deals waiting in the pipeline, the recent upturn in M&A activity raises the question of how far this erosion will continue.

Several senior bankers told IFR and LPC that they are increasingly rejecting underwrites solely as the covenant terms and leverage levels requested by sponsors are too aggressive.

“I’m worried about it; the documentation is not pretty. We have more internal checks and committees now on deal terms and that’s paramount,” one leveraged finance head said.

In the recent auction for Sanofi’s generics business Zentiva, the banks underwriting one of the losing bids asked to reduce their commitments due to concern over the aggressiveness of the deal, a banker said.

The loan financing backing Zentiva’s buyout was launched to general syndication on Friday.

Although some lenders are voting with their feet, sponsors have many banks to choose from and are dealing with dissent harshly. Two senior bankers told IFR they have been kicked off deals for resisting aggressive terms.

“The number of bank participants trying to lead arrange transactions is such that, in a good, high-quality asset, you might have 20 banks trying to lead a deal. So sponsors are in a position to impose their documentation and get away with it,” one of the bankers said.

Bankers are also concerned about the extension of aggressive documentation designed for top credits to smaller middle market companies, as investors become increasingly selective about credit.

“2017 might have made people complacent as anything could get done and done aggressively. The market has gone from being aggressive on strong credits to as aggressive on the weakest credits as well,” the leveraged finance head said.

The upcoming A$500m-equivalent covenant-lite sterling term loan backing Carlyle’s buyout of Accolade Wines has similar debt incurrence capacity to the largest deals, a senior market participant said.

“It always feels like the market has two faces – overheated or shut. It was the former and now it feels that some of those underwrites were reckless. Some of those deals will struggle if done that aggressively now, so do you want to roll the dice on them as a bank?” a syndicate head said.

Several loans and bonds have struggled to attract investors this year, including Afriflora’s €280m term loan, which was eventually offered with a discount of 93, and Algeco Scotsman’s €1.145bn-equivalent high-yield bond, which had to amend covenants and tranching and drop prices to as low as 94 to get over the line.


Bankers’ concerns reflect increased investor activism, as protests mount about the erosion of key protections designed to stop issuers from taking action that could hurt lenders and act as warning signals when a company’s credit metrics deteriorate.

High-yield bankers are particularly disturbed by terms that allow companies to use the proceeds of asset sales to pay dividends and the ability to pay dividends when firms default.

Loan investors are especially worried about how quickly some credits can pay dividends, along with looser cash sweep provisions which mandatorily repay debt from free cashflow.

The growing influence of law firms in forming leveraged finance deals is also accelerating the drive towards ever looser lending terms, bankers said.

“There’s a lot of creative license to what the lawyers are doing. Lending agreements are meant to be well-drafted and structured and I don’t think some of the lawyers, with no skin in the game, really appreciate what they’re doing to the market,” added the first banker.

High-yield bond investors are pushing back on more deals this year than in 2017, in the context of a weaker market backdrop and outflows from the asset class. Resistance is still largely confined to struggling deals and troubled credit stories.

“It is frustrating where nobody pushes back on deals where there’s particularly loose documentation that’s flagged by the media, by the rating agencies, by everybody in the market, just because they like the credit,” said another syndicate head.

“It makes it hard to argue to a sponsor that they should be more sensible with the documentation that they bring to the market,” he added.

The third syndicate banker said that investors need to consistently reject certain terms before underwriters can tell sponsors that it is absolutely unachievable.

The recent buyout deal backing Unilever’s spreads business Flora Food Group by KKR had a covenant package rated as the weakest ever on a euro-denominated bond by rating agency Moody’s, but pricing on the deal was tightened after investors piled in.

While bankers agree that both the high-yield bond and leveraged loan markets are leaving their peaks behind, they do not expect private equity firms to reign in their requests until they learn a painful lesson. “It will only happen when you have deals where the market pushes back, but sponsors stick banks with the deal because it is already underwritten and the deal gets hung. Until then, things won’t change,” the second syndicate head said.

Reporting by Yoruk Bahceli and Max Bower; editing by Tessa Walsh

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