Leveraged Commentary & Data A Guide To The European Loan Market

February 2012

Leveraged Commentary & Data A Guide To The European Loan Market

February 2012

www.lcdcomps.com Copyright © 2012 by Standard & Poor’s Financial Services LLC. All rights reserved. No content (including ratings, credit-related analyses and data, model, software, or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced, or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees, or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness, or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment, and experience of the user, its management, employees, advisors, and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P’s public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www. globalcreditportal.com (subscription), and may be distributed through other means, including via S&P publications and third- party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.

2 Leveraged commentary & data february 2012 www.spcapitaliq.com To Our Clients

his sixth edition of Leveraged Commentary & Data - A Guide To The European Loan Market Tcovers a gamut of topics on the European leveraged loan market, including secondary trad- ing, default, restructurings, and recovery. In addition, as usual, we have also updated and amended our primer on the European leveraged loan market. In 2011, leveraged loans had a year of two halves: a strong first half of the year followed by a weaker second half on the back of the fallout from the European sovereign risk contagion. The European high-yield market as well as the broader capital markets were also shut in the second half of 2011 as investors decided to “de-risk.” The absence of the high-yield market in particular hurt the loan market, as the high-yield market was the main driver of repayments to loans. However, 2011 is different from 2008, which saw waves of forced selling in the secondary mar- ket. Nonetheless, some arrangers were left with a significant primary overhang of loans, some of which was sold down. This overhang, along with the end of European CLO reinvestment peri- ods, general weak economic-activity, and the implementation of Basel III and the capital requirements regulation (CRD IV), will make 2012 a challenging one for investors and issuers. We expect 2012 to be a more challenging year for corporate credit quality in Europe as euro- zone sovereigns continue their struggle to reconcile the twin problems of reducing debt while supporting growth against the background of growing political discord. Stronger corporates typically capitalized on the 2009-2011 economic rebound to strengthen their balance sheets and liquidity and are reasonably well placed to weather the mild recession that we now envisage for Europe in the early part of 2012. Nonetheless, we believe that we are entering a period where corporate credit performance will become far more sensitive to the strength and weight of the domestic (“local”) market in generating earnings given the volatile and uncertain economic out- look in the EU. This means that more “local” companies with a high dependency on depressed demand conditions in EU austerity countries will be most exposed, irrespective of the perceived cyclicality of the sector in which the company operates. In our view, the escalation of the eurozone sovereign crisis will herald a renewed step-up in corporate defaults over the next couple of years for at least three reasons. First, and most obvi- ously, business prospects in Europe have taken a turn for the worse, with at least a shallow recession now in prospect for the first half of 2012. Second, the gradual improvement seen in the availability of debt financing since the summer of 2009 has hit a brick wall. Thirdly, and somewhat related to the second factor in our view, is that the policy of forbearance by senior lenders is reaching its limits given the proximity to principle maturity dates in 2013-2014. If you want to learn more about our loan market services, all the appropriate contact information is listed in the back of this publication. We welcome questions, suggestions, and feedback on our products and services, and on this Guide. You can access this report and other relevant articles on LCD’s website, www.lcdcomps.com, and current loan, high-yield, including selected Standard & Poor’s recovery reports and analyses and a comprehensive list of Standard & Poor’s bank loan and recovery ratings at www.sandprecoveryratings.com.

Sucheet Gupte Paul Drake

A Guide To The European Loan Market february 2012 3 www.spcapitaliq.com Contents

A Primer For The European Syndicated Loan Market ...... 5

Glossary ...... 26......

Boom And Bust Again In 2011 ...... 32 ......

Eurozone Risks Will Weigh On Corporates If They Can’t Find Growth Globally ...... 39

The Future Of Corporate Funding: Filling The Leveraged Loan Gap In Europe ...... 48. .

Why Refinancing Bank Debt With Bonds In Europe Lowers Recovery Expectations . . . .53 .

European Leveraged Loans Face Funding Hiatus As CLO Vehicles’ Support Wanes . . . .57 .

Key Contacts ...... 82

Leveraged commentary & data february 2012 4 www.spcapitaliq.com A Primer For The European Syndicated Loan Market

Ruth McGavin orporate lending is a key route that European companies use to London (44) 20-7176-3924 Caccess the debt markets, combined with increasing issuance into [email protected] the high-yield bond market. Since the euro launched in 1999, the Marina Lukatsky New York syndicated loan market in particular has become the dominant way for (1) 212-438-2709 marina_lukatsky@ European issuers to tap banks and other institutional capital providers spcapitaliq.com for loans.

A syndicated loan is one that is provided by plain-vanilla loan, typically an unsecured a group of lenders and is structured, revolving credit instrument that is used to arranged, and administered by one or sev- provide support for short-term commercial eral commercial or investment banks known paper borrowings or for working capital. In as arrangers. They are less expensive and many cases, moreover, these borrowers will more efficient to administer than traditional effectively syndicate a loan themselves, using bilateral, or individual, credit lines. the arranger simply to craft documents and At the most basic level, arrangers raise administer the process. For leveraged investor funds for an issuer in need of issuers, the story is a very different one for capital. The issuer pays the arranger a fee the arranger, and, by “different,” we mean for this service, and, naturally, this fee more lucrative. A new leveraged loan can increases with the loan’s complexity and carry an arranger fee of 1% to 5% of the total riskiness of the loan. As a result, the most loan commitment, generally speaking, profitable loans are those to leveraged depending on (1) the complexity of the borrowers—issuers whose credit ratings are transaction, (2) how strong market speculative grade and who are paying conditions are at the time, and (3) whether spreads (premiums above LIBOR or another the loan is underwritten. Merger and base rate) sufficient to attract the interest acquisition (M&A) and recapitalization loans of nonbank term loan investors, typically will likely carry high fees, as will exit LIBOR+200 basis points (bp) or higher, financings and restructuring deals. Seasoned though this threshold moves up and down leveraged issuers, by contrast, pay lower fees depending on market conditions. In the U.S., for refinancings and add-on transactions. corporate borrowers and private equity Because investment-grade loans are sponsors fairly even-handedly drive debt infrequently used and, therefore, offer issuance. Europe, however, has far less drastically lower yields, the ancillary business corporate activity and its issuance is is as important a factor as the credit product dominated by private equity sponsors, who, in arranging such deals, especially because in turn, determine many of the standards many acquisition-related financings for and practices of loan syndication. investment-grade companies are large in Indeed, large high-quality, or investment- relation to the pool of potential advisors, grade, companies pay little or no fee for a which would consist solely of banks.

A Guide To The European Loan Market february 2012 5 www.spcapitaliq.com The “retail” market for a syndicated loan and institutional investors. Before formally consists of banks and, in the case of launching a loan to these retail accounts, leveraged transactions, finance companies, arrangers will often get a market read by hedge funds, and institutional investors. informally polling select investors to gauge The balance of power among these their appetite for the credit. Based on these different investors groups is different in the discussions, the arranger will launch the U.S. than in Europe. The U.S. has a capital credit at a spread and fee it believes will market where pricing is linked to credit clear the market. In the early years of the quality and institutional investor appetite. market, once the pricing was set, it was set, In Europe, although institutional investors except in the most extreme cases. If the have increased their market presence over loan were undersubscribed, the arrangers the past few years, banks remain a key part could very well be left above their desired of the market. Consequently, although hold level. After the 2007 credit crunch, market-flex language has become however, arrangers have adopted market- standard, pricing is not yet fully driven by flex language, which allows them to change capital market forces. the pricing of the loan based on investor Banks have historically dominated the demand—in some cases within a European debt markets because of the predetermined range—as well as shift intrinsically regional nature of the arena. amounts between various tranches of a Regional banks have traditionally funded loan, as a standard feature of loan local and regional enterprises because they commitment letters. are familiar with regional issuers and can Initially, arrangers invoked flex language to fund in the local currency. Since the eurozone make loans more attractive to investors by was formed in 1998, the growth of the hiking the spread or lowering the price. European leveraged loan market has been However, market-flex can also been used as fuelled by the efficiency provided by this a tool either to increase or decrease pricing single currency as well as an overall growth in of a loan, based on investor reaction. M&A activity, particularly leveraged buyouts Using market flex, a loan syndication today (LBO) due to private equity activity. Regional can functions as a “book-building” exercise, barriers (and sensitivities toward in bond-market parlance. A loan is originally consolidation across borders) have fallen, launched to market at a target spread or with economies have grown, and the euro has a range of spreads referred to as price talk helped to bridge currency gaps. (i.e., a target spread of, say, LIBOR+250 to Until the credit crunch hit, more and more LIBOR+275). Investors then will make com- leveraged buyouts occurred and grew in size mitments that in many cases are tiered by as arrangers have been able to raise bigger the spread. For example, an account may put pools of capital to support larger, in for $25 million at LIBOR+275 or $15 mil- multinational transactions. To fuel the lion at LIBOR+250. At the end of the process, growing market, a broader array of banks the arranger will total up the commitments from multiple regions now funds these deals, and then make a call on where to price the along with European institutional investors as paper. Following the example above, if the well as U.S. institutional investors. The LBO paper is oversubscribed at LIBOR+250, the market has since begun to recover, and arranger may slice the spread further. although these deals are not as aggressive Conversely, if it is undersubscribed even at as they were in the bull market days, LIBOR+275, then the arranger will be forced syndication does follow a similar pattern. to raise the spread to bring more money to The European market has taken the table. advantage of many of the lessons from the U.S. market while maintaining its regional diversity. In Europe, the regional diversity Types Of Syndications allows banks to maintain a significant Globally, there are three types of lending influence and fosters private syndications: an underwritten deal, a equity’s dominance in the market. “best-efforts” syndication, and a “club The “retail” market for a syndicated loan deal.” The European leveraged syndicated consists of banks and, in the case of loan market almost exclusively consists of leveraged transactions, finance companies underwritten deals, whereas best-efforts

6 Leveraged commentary & data february 2012 www.spcapitaliq.com A Primer For The European Syndicated Loan Market

deals are common in the U.S. for The Syndication Process opportunistic transactions. Purpose and preparation in leveraged lending Leveraged transactions fund a number of Underwritten deal purposes. They provide support for general An underwritten deal is one for which the corporate purposes, including capital arrangers guarantee the entire expenditures, working capital, and expansion. commitment, and then syndicate the loan. They refinance the existing capital structure If arrangers cannot fully subscribe the loan, or support a full recapitalization including, they are forced to absorb the difference, not infrequently, the payment of a dividend to which they may later try again to sell to the equity holders. Their primary purpose, investors. This is easy, of course, if market however, is to fund M&A activity, specifically conditions or the credit’s fundamentals leveraged buyouts, where the buyer uses the improve. If not, the arranger may be forced debt markets to acquire the acquisition to sell at a discount and, potentially, even target’s equity. take a loss on the paper. Or the arranger The core of European leveraged lending may just be left above its desired hold level comes from borrowers owned by private of the credit. So, why do arrangers equity funds. In the U.S., these are called underwrite loans? First, offering an “sponsored transactions.” In Europe, all underwritten loan can be a competitive tool sponsor-related activity, including to win mandates. Second, underwritten refinancings and recapitalizations, are loans usually require more lucrative fees referred to as LBOs. because the agent is on the hook if The transaction originates well before potential lenders balk. Of course, with flex- lenders see the transaction’s terms. In an language now widely accepted, LBO, the company is first put up for auction. underwriting a deal does not carry the A company that is for the first time up for same risk as it did when the pricing was set sale to private equity sponsors is a primary in stone before syndication. LBO. A secondary LBO is one that is going from one sponsor to another sponsor (and a Best-efforts syndication tertiary LBO is one that is going for the A best-efforts syndication is one for which second time from sponsor to sponsor). A the arranger group commits to underwrite public-to-private transaction (P2P) occurs less than the entire amount of the loan, when a company is going from the public leaving the credit to the vicissitudes of the domain to a private equity sponsor. market. If the loan is undersubscribed, the As prospective acquirers are evaluating credit may not close—or may need major target companies, they are also lining up surgery to clear the market. debt financing. A staple financing package may be on offer as part of the sale process. Club deal By the time the auction winner is announced, A “club deal” is a smaller loan (usually €50 that acquirer usually has funds lined up via a million-€150 million, but as high as €300 financing package funded by its designated million) that is premarketed to a group of mandated lead arrangers (MLA). relationship lenders. The arranger is Where the loan is not part of a generally a first among equals, and each competitive auction, an issuer usually lender gets a full cut, or nearly a full cut, of solicits bids from arrangers before the fees. Club deals are traditionally rare awarding a mandate. The competing banks from the perspective of transactions will outline their syndication strategy and syndicated across regions, but they are qualifications, as well as their view on the common regional plays in Europe, where way the loan will price in the market. In regional banks provide the funding. Europe, where mezzanine funding is a Club deals became much more prominent market standard, issuers may choose to during 2008/2009 as the credit crunch pursue a dual track approach to sidelined the bulk of institutional investors, syndication whereby the MLAs handle the and banks scaled back their lending. During senior debt and a specialist mezzanine this period club deals of more than €150 fund oversees placement of the million became common. subordinated mezzanine portion.

A Guide To The European Loan Market february 2012 7 www.spcapitaliq.com The information memo, or “bank book” structure, collateral, covenants, and other Before awarding a mandate, an issuer might terms of the credit (covenants are usually solicit bids from arrangers. The banks will negotiated in detail after the arranger outline their syndication strategy and receives investor feedback). qualifications, as well as their view on the •• The industry overview will describe the way the loan will price in the market. Once company’s industry and competitive posi- the mandate is awarded, the syndication tion relative to its industry peers. process starts. The arranger will prepare an •• The financial model will be a detailed information memo (IM) describing the terms model of the issuer’s historical, pro forma, of the transactions. The IM typically will and projected financials including man- include an executive summary, investment agement’s high, low, and base case for considerations, a list of terms and conditions, the issuer. an industry overview, and a financial model. Most new acquisition-related loans are Because loans are not securities, this will be kicked off at a bank meeting at which a confidential offering made only to qualified potential lenders hear management and the banks and accredited investors. sponsor group (if there is one) describe what If the issuer is speculative grade and the terms of the loan are and what seeking capital from nonbank investors, the transaction it backs. Some bank meetings arranger will often prepare a “public” version are conducted via a Webex or conference of the IM. This version will be stripped of all call, although many issuers prefer in- confidential material such as management person gatherings. financial projections so that it can be viewed At the meeting, management will provide by accounts that operate on the public side its vision for the transaction and, most of the wall or that want to preserve their important, tell why and how the lenders will ability to buy bonds or stock or other public be repaid on or ahead of schedule. In securities of the particular issuer (see the addition, investors will be briefed regarding Public Versus Private section). Naturally, the multiple exit strategies, including second investors that view materially nonpublic ways out via asset sales. (If it is a small deal information of a company are disqualified or a refinancing instead of a formal meeting, from buying the company’s public securities there may be a series of calls or one-on-one for some period of time. meetings with potential investors.) As the IM (or “bank book,” in traditional Once the loan is closed, the final terms are market lingo) is being prepared, the then documented in detailed credit and syndicate desk will solicit informal feedback security agreements. Subsequently, liens are from potential investors on what their perfected and collateral is attached. appetite for the deal will be and at what Loans, by their nature, are flexible price they are willing to invest. Once this documents that can be revised and amended intelligence has been gathered, the agent from time to time. These amendments will formally market the deal to potential require different levels of approval (see investors. Arrangers will distribute most Voting Rights section). Amendments can IMs—along with other information related range from something as simple as a to the loan, pre- and post-closing—to covenant waiver to something as complex as investors through digital platforms. Leading a change in the collateral package or allowing vendors in this space are Intralinks, Syntrak, the issuer to stretch out its payments or and Debt Domain. make an acquisition. The IM typically contain the following sections: The loan investor market •• The executive summary will include a Loans are “launched” to the market in a description of the issuer, an overview of series of steps. The roles of each of the the transaction and rationale, sources and players in the each of those phases are based uses, and key statistics on the financials. on their relationships in the market and •• Investment considerations will be, basi- access to paper. On the arrangers’ side, the cally, management’s sales “pitch” for players are determined by how well they can the deal. access capital in the market and bring in •• The list of terms and conditions will be a pre- lenders. On the lenders’ side, it’s about liminary term sheet describing the pricing, getting access to as many deals as possible.

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There are three primary phases of Through 2005-2007, CLOs became the syndication. During the underwriting phase, dominant institutional investor vehicle in the sponsor or corporate borrower Europe, but other vehicles, such as credit designates the MLA (or the group of MLAs) funds, also took a share of the market. This and the deal is initially underwritten. During share began to fall, once the 2007 credit the subunderwriting phases, other arrangers crunch halted CLO issuance in Europe. are brought into the deal. In general Credit funds are open-ended pools of debt syndication, the transaction is opened up to investments. Unlike CLOs, however, they are the institutional investor market, along with not subject to ratings oversight or other banks that are interested in restrictions regarding industry or rating participating in the transaction. diversification. They are generally lightly There are two primary investor levered (two to three times) or unlevered and constituencies in Europe: banks and allow managers significant freedom in institutional investors. picking and choosing investments and are Banks, in this case, can be either a subject to being marked to market. commercial bank, a savings and loan Mezzanine funds are also investment institution, or a securities firm that usually pools, which traditionally focused on the provides investment- grade loans. These are mezzanine market only. However, when typically large revolving credits that back second lien entered the market, it eroded the commercial paper or are used for general mezzanine market. Consequently, mezzanine corporate purposes or, in some cases, funds expanded their investment universe acquisitions. In Europe, the banking segment and began to commit to second lien as well is almost exclusively made up of commercial as payment-in-kind (PIK) portions of banks. For leveraged loans, banks typically transactions. As with credit funds, these provide any unfunded revolving credits, pools are not subject to ratings oversight or letters of credit (LOC), and amortizing term diversification requirements, and allow loans, under a syndicated loan arrangement. managers significant freedom in picking and Institutional investors in the loan market choosing investments. Mezzanine funds are, are principally structured vehicles known as however, riskier than credit funds in that they collateralized loan obligations (CLO). In carry both debt and equity characteristics. addition, private equity funds, hedge funds, Prime funds allow U.S. retail investors to high-yield bond funds, pension funds, access the loan market. They are mutual insurance companies, and other proprietary funds that invest in leveraged loans and are investors also participate in loans. sold only in the U.S.—there is no European CLOs are special-purpose vehicles set up equivalent. However, U.S. prime funds have to hold and manage pools of leveraged loans. made significant allocations to investments The special-purpose vehicle is financed with in European loans; an estimated 10% of several tranches of debt (typically a ‘AAA’ some of the largest funds in the U.S. are rated tranche, a ‘AA’ tranche, a ‘BBB’ tranche, available for funding European loans. and a mezzanine tranche) that have rights to the collateral and payment stream in descending order. In addition, there is an Public Versus Private equity tranche, but the equity tranche is In Europe, the line between public and usually not rated. CLOs are created as private information in the loan market is far arbitrage vehicles that generate equity simpler than in the U.S. European loans are returns through leverage, by issuing debt 10 strictly on the private side of the wall and to 11 times their equity contribution. There any information transmitted between the also are market-value CLOs that are less issuer and the lender group is considered leveraged—typically three to five times—and confidential. High-yield bonds are public allow managers more flexibility than more instruments. However, because most tightly structured arbitrage deals. CLOs are European debt is in the form of loans, usually rated by two of the three major privacy reigns. ratings agencies and impose a series of In the U.S., since the late 1980s, that line covenant tests on collateral managers, has begun to blur as a result of two market including minimum rating, industry innovations. The first was more active diversification, and maximum default basket. secondary trading that sprung up to support

A Guide To The European Loan Market february 2012 9 www.spcapitaliq.com (1) the entry of nonbank investors in the complexes that do have public funds and market, such as insurance companies and portfolios but, via Chinese walls, are loan mutual funds and (2) to help banks sell sealed from these parts of the firms. rapidly expanding portfolios of distressed and There are also accounts that are public. highly leveraged loans that they no longer These firms take only public IMs and pub- wanted to hold. This meant that parties that lic materials and, therefore, retain the were insiders on loans might now exchange option to trade in the public securities confidential information with traders and markets even when an issuer for which potential investors who were not (or not yet) they own a loan is involved. This can be a party to the loan. The second innovation tricky to pull off in practice because in the that weakened the public-private divide was case of an amendment the lender could trade journalism that focuses on the loan be called on to approve or decline in the market. In Europe, the same trends began to absence of any real information. Or, the emerge, thanks in part to a period of rapid account could either designate one per- growth in the institutional investor base. son who is on the private side of the wall Nonetheless, there has been growing to sign off on amendments or empower concern among issuers, lenders, and its trustee or the loan arranger to do so. regulators in the U.S. and Europe that this But it’s a complex proposition. migration of once-private information into •• Vendors. Vendors of loan data, news, and public hands might breach confidentiality prices also face many challenges in man- agreements between lenders and issuers aging the flow of public and private infor- and, more importantly, could lead to illegal mation. In general, the vendors operate trading. The market has contended with under the freedom of the press provision these issues through: of the U.S. Constitution’s First •• Traders. To insulate themselves from vio- Amendment and report on information in lating regulations, some dealers and buy- a way that anyone can simultaneously side firms have set up their trading desks receive it—for a price of course. on the public side of the wall. Therefore, the information is essentially Consequently, traders, salespeople, and made public in a way that doesn’t deliber- analysts do not receive private information ately disadvantage any party, whether it’s even if somewhere else in the institution a news story discussing the progress of the private data are available. This is the an amendment or an acquisition, or it’s a same technique that investment banks price change reported by a mark-to-mar- have used from time immemorial to sepa- ket service. This, of course, doesn’t deal rate their private investment banking with the underlying issue that someone activities from their public trading and who is a party to confidential information sales activities. is making it available via the press or •• Underwriters. As mentioned above, in prices to a broader audience. most primary syndications, arrangers will Another way in which participants deal with prepare a public version of an information the public-versus-private issue is to ask memo that is scrubbed of private infor- counterparties to sign “big-boy” letters. mation like projections. These IMs will be These letters typically ask public-side distributed to accounts that are on the institutions to acknowledge that there may public side of the wall. As well, underwrit- be information they are not privy to and they ers will ask public accounts to attend a are agreeing to make the trade in any case. public version of the bank meeting and They are, effectively, “big boys” who will distribute to these accounts only accept the risks. scrubbed financial information. •• Buy-side accounts. On the buy side there are firms that operate on either side of Credit Risk: An Overview the public-private fence. Accounts that Pricing a loan requires arrangers to evaluate operate on the private side receive all the risk inherent in a loan and to gauge confidential materials and agree to not investor appetite for that risk. The principal trade in public securities of the issuers for credit risk factors that banks and which they get private information. These institutional investors contend with in buying groups are often part of wider investment loans are default risk and loss-given-default

10 Leveraged commentary & data february 2012 www.spcapitaliq.com A Primer For The European Syndicated Loan Market

risk. Among the primary ways that accounts Up until the end of 2008, ratings in Europe judge these risks are ratings, credit statistics, were still primarily private, but as of industry sector trends, management December 2008, Standard & Poor’s will no strength, and sponsor. All of these, together, longer give credit estimates on deals where tell a story about the deal. the debt is worth more than €750 million, Brief descriptions of the major risk signaling a shift toward a greater role for factors follow. public ratings in Europe.

Default risk Loss-given-default risk Default risk is simply the likelihood of a Loss-given-default risk measures how severe borrower’s being unable to pay interest or a loss the lender would incur in the event of principal on time. It is based on the issuer’s default. Investors assess this risk based on financial condition, industry segment, and the collateral (if any) backing the loan as well conditions in that industry and economic as the amount of any priority debt and other variables and intangibles, such as company claims that may affect the likely level of management. Default risk is most visibly recoveries. Lenders will also look to expressed by a public rating from Standard covenants to provide a way of coming back to & Poor’s Ratings Services or another ratings the table early—that is, before other agency. These ratings range from ‘AAA’ for creditors—and renegotiating the terms of a the most creditworthy loans to ‘CCC’ for the loan if the issuer fails to meet financial least. The market is divided, roughly, into targets. Investment-grade loans are, in most two segments: investment grade (loans cases, senior unsecured instruments with rated ‘BBB-’ or higher) and leveraged loosely drawn covenants that apply only at (borrowers rated ‘BB+’ or lower). Default incurrence, that is, only if an issuer makes an risk, of course, varies widely within each acquisition or issues debt. As a result, loss of these broad segments. given default may be no different from risk The European market is less transparent incurred by other senior unsecured creditors. because public ratings are not commonly Leveraged loans, by contrast, are, in virtually required to get a deal syndicated. This is a all cases, senior secured instruments with by-product of the bank dominance of the tightly drawn maintenance covenants, i.e., investor market as well as the strong covenants that are measured at the end of relationship that exists between lenders and each quarter whether or not the issuer sponsors. Investors rely on their own carries out any additional fund raising. Loan understanding of default risk and their own holders, therefore, almost always are first in assessment of the credit, rather than relying line among prepetition creditors and, in many on independent credit analysis. CLO cases, are able to renegotiate with the issuer managers need ratings on the credits they before the loan becomes severely impaired. It invest in, to comply with their internal tests, is no surprise, then, that loan investors but they usually obtain private “credit historically fare much better than other estimates” from ratings agencies, rather creditors on a loss-given-default basis. than full public ratings. It is important to note that default risk is Credit statistics much harder to quantify in Europe than in Credit statistics are used by investors to help the U.S. because distressed transactions calibrate both default risk and loss-given- tend to privately restructure rather than default risk. These statistics include a broad publicly default. Due to the nature of the array of financial data, including credit ratios U.S. bankruptcy courts, their transparency measuring leverage (debt to capitalization and focus on restructuring versus and debt to EBITDA) and coverage (EBITDA to liquidation, both borrowers and lenders are interest, EBITDA to debt service, operating comfortable with public defaults. In Europe, cash flow to fixed charges). Of course, the both parties are subject to the vagaries of ratios investors use to judge credit risk vary the array of bankruptcy regimes; as a by industry. In addition to looking at trailing result, they are more likely to come to a and pro forma ratios, investors look at private restructuring and the influence and management’s projections and the support provided by sponsors in these assumptions behind these projections to see events cannot be underestimated. if the issuer’s game plan will allow it to pay

A Guide To The European Loan Market february 2012 11 www.spcapitaliq.com its debt comfortably. There are ratios that Syndicating A Loan By Facility are most geared to assessing default risk. Most loans are structured and syndicated to These include leverage and coverage. Then accommodate the two primary syndicated there are ratios that are suited for evaluating lender constituencies: banks (domestic and loss-given-default risk. These include foreign) and institutional investors (primarily collateral coverage, or the value of the structured finance vehicles, mutual funds, collateral underlying the loan relative to the and insurance companies). As such, size of the loan. The ratio of senior secured leveraged loans consist of two parts: loans to junior debt in the capital structure is •• Pro rata debt consists of the revolving also used. Logically, the likely severity of credit and amortizing term loan (TLa), loss-given-default for a loan increases with which are packaged together and, usually, the size of the loan as a percentage of the syndicated to banks. In some loans, how- overall debt structure. After all, if an issuer ever, institutional investors take pieces of defaults on $100 million of debt, of which the TLa and, less often, the revolving $10 million is in the form of senior secured credit, as a way to secure a larger institu- loans, the loans are more likely to be fully tional term loan allocation. Why are these covered in bankruptcy than if the loan tranches called “pro rata”? Because totals $90 million. arrangers historically syndicated revolving credit and TLas on a pro rata basis to Industry sector banks and finance companies. Industry is a factor, because sectors, •• Institutional debt consists of term loans naturally, go in and out of favor. For that structured specifically for institutional reason, having a loan in a desirable sector can investors, although there are also some really help a syndication along. Also, loans to banks that buy institutional term loans, issuers in defensive sectors (like consumer especially in Europe. These tranches used products) can be more appealing in a time of to include first-lien TLb and TLc facilities, economic uncertainty, whereas cyclical and second-lien loans, although TLc borrowers (like chemicals or autos) can be tranches have become rare since the 2007 more appealing during an economic upswing. credit crunch. Traditionally, institutional The European market is not as industry tranches were referred to as TLbs because diversified as the U.S. market, and is primarily they were bullet payments and lined up dominated by a handful of industries such as behind TLas. cable, telecom, services, and chemicals. The mechanism of structural flex allows arrangers to adapt the overall distribution Sponsorship of debt between first lien, second lien, and Sponsorship is a factor, too. Needless to say, mezzanine to current market conditions. many leveraged companies are owned by Under highly liquid market conditions, one or more private equity firms. These arrangers can structurally “flex” the deal by entities, such as Kohlberg Kravis & Roberts moving debt from the more expensive or Carlyle Group, invest in companies that tranches, such as mezzanine, to less have leveraged capital structures. To the expensive tranches, like second or first lien. extent that the sponsor group has a strong Likewise, in more difficult times, arrangers following among loan investors, a loan will can do the opposite and move debt from be easier to syndicate and, therefore, can be first lien into second lien and second lien priced lower. In contrast, if the sponsor into mezzanine to complete syndication group does not have a loyal set of of the debt. relationship lenders, the deal may need to be priced higher to clear the market. Among Pricing A Loan In The Primary Market banks, investment factors may include whether or not the bank is party to the Pricing loans for the U.S. institutional sponsor’s equity fund. Among institutional market is a straightforward exercise based investors, weight is given to an individual on simple risk/return consideration and deal sponsor’s track record in fixing its own market technicals. Pricing loans for the U.S. impaired deals by stepping up with bank market, however, is more complex. additional equity or replacing a management Indeed, banks often invest in loans for more team that is failing. than pure spread income—they are also

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driven by the overall profitability of the from leveraged loans entirely, while others issuer relationship, including noncredit decided they could only lend if they earned revenue sources. additional fees from an arranging role. Others Pricing loans in Europe is a simpler, but continue to run a portfolio of leveraged loans, less efficient, process because pricing is not and do so without needing ancillary business as flexible and market-driven as it is in the to make the investment more attractive. On U.S. For many years, the European market the whole, the spread is of lesser importance had a well-established pricing “standard” to a typical European bank lender, compared where most deals started out. The pro rata with the bank’s own internal assessment of tranches usually began general syndication the credit risk. at Euribor+225. The institutional tranches As of September 2011, banks still made were each usually priced up by about 50 bps up 46% of the loan investor base. However, so the TLb was at Euribor+275 and the TLc at the bank landscape was shifting through Euribor+325. 2011 and was expected to continue to Until the market turned in July 2007, a change as banks reassess their commitment rapidly decreasing number of deals opened at to the product. Banks that do stay engaged the old “standard” levels, and these were are likely to become more focused on mainly more difficult or less liquid credits. spreads, to make leveraged lending The majority of mainstream deals launched attractive despite the risk capital at the slightly lower level of requirements imposed by Basel III. Euribor+200/250/300, in response to heavy demand for assets. However, once the market Pricing loans for institutional players slowed down, the opening spread level on In pricing loans to institutional investors, it’s deals began to rise back up to, as well as a matter of the spread of the loan relative to above, the old “standard” levels. credit quality and market-based factors. This During the credit crunch of 2008/2009, second category can be divided into liquidity opening spreads increased to between and market technicals (i.e., supply/demand). Euribor+400-500 across the TLa and TLb, in Liquidity is the tricky part, but, as in all response to the higher return requirements markets, all else being equal, more liquid of investors, and have remained in that area instruments command thinner spreads than or higher since. less liquid ones. In the old days—before Market flex language has also played a big institutional investors were the dominant part in adjusting spreads to market liquidity investors and banks were less focused on levels. Over the past few years, Europe portfolio management—the size of a loan adopted the U.S. practice of using market flex didn’t much matter. Loans sat on the books language to adapt pricing during general of banks and stayed there. But now that syndication a little more to market institutional investors and banks put a conditions. Until the liquidity crunch, the vast premium on the ability to package loans and majority of flexes were downward, allowing sell them, liquidity has become important. As borrowers to take advantage of the current a result, smaller executions—generally those hyper-liquid market conditions by reducing of $200 million or less—tend to be priced at a pricing and only a handful of upward flexes premium to the larger loans. Of course, once had occurred to make transactions struggling a loan gets large enough to demand in syndication more appealing to investors. extremely broad distribution, the issuer However, once the market turned bearish, usually must pay a size premium. The market flex language allowed arrangers to thresholds range widely. During the go-go upward flex pricing in an effort to reengage mid-2000s, it was upwards of $10 billion. reluctant investors. During the more parsimonious late-2000s, $1 billion was considered a stretch. Pricing loans for bank investors Market technicals, or supply relative to Banks operating in the European market vary demand, is a matter of simple economics. If considerably in their approach to booking risk there are a lot of dollars chasing little in the form of leveraged loans. product, then, naturally, issuers will be able to Over time, thanks in part to tightening command lower spreads. If, however, the regulation governing core capital opposite is true, then spreads will need to requirements, some firms have stepped away increase for loans to clear the market.

A Guide To The European Loan Market february 2012 13 www.spcapitaliq.com Relative value. Institutional investors can dicate group. The agent will conduct what buy paper in the secondary market as well as amounts to an auction to raise funds for in primary, so arrangers also have to price the borrower, and the best bids are primary issuance to be competitive against accepted. CBOs typically are available only the value on offer in secondary. This can to large, investment-grade borrowers. include the trading price of the issuer’s •• A term-out will allow the borrower to con- outstanding debt (if any), the price of vert borrowings into a term loan at a given comparable loans, and the price of conversion date. This, again, is usually a comparable high-yield bonds. feature of investment-grade loans. Under the option, borrowers may take what is outstanding under the facility and pay it off Types Of Syndicated Loan Facilities according to a predetermined repayment There are four main types of syndicated schedule. Often the spreads ratchet up if loan facilities: the term-out option is exercised. •• A revolving credit (within which are options •• An evergreen is an option for the bor- for swingline loans, multicurrency-borrow- rower—with consent of the syndicate ing, competitive-bid options, term-out, and group—to extend the facility each year evergreen extensions); for an additional year. •• A term loan; A term loan is simply an installment loan, •• An LOC; and such as a loan one would use to buy a car. •• An acquisition or equipment line The borrower may draw on the loan during a (a delayed-draw term loan). short commitment period and repays it A revolving credit line allows borrowers to based on either a scheduled series of draw down, repay, and reborrow as often as repayments or a one-time lump-sum necessary. The facility acts much like a payment at maturity bullet payment). There corporate credit card, except that borrowers are two principal types of term loans: are charged an annual commitment fee on •• An amortizing term loan (A-term loans, or unused amounts, which drives up the overall TLa) is a term loan with a progressive cost of borrowing (the facility fee). Revolvers repayment schedule that typically runs six to speculative-grade issuers in the U.S. are years or less in the U.S., or seven years in often tied to borrowing-base lending Europe. These loans are normally syndi- formulas. This limits borrowings to a certain cated to banks along with revolving credits percentage of collateral, most often as part of a larger syndication. receivables and inventory. In Europe, •• An institutional term loan (B-term, C-term, revolvers are primarily designated to fund or D-term loans) is a term-loan facility working capital or capital expenditures with a portion carved out for nonbank, (capex). Revolving credits often run for 364 institutional investors. These loans are days. These revolving credits—called, not priced higher than amortizing term loans surprisingly, 364-day facilities—are generally because they have longer maturities and limited to the investment-grade market. The bullet repayment schedules. This institu- reason for what seems like an odd term is tional category also includes second-lien that regulatory capital guidelines mandate loans and “covenant-lite” loans, which are that, after one year of extending credit under described below. a revolving facility, banks must then increase LOCs differ, but, simply put, they are their capital reserves to take into account the guarantees provided by the bank group unused amounts. Therefore, banks can offer to pay off debt or obligations if the issuers 364-day facilities at a lower unused borrower cannot. fee than a multiyear revolving credit. There Acquisition/equipment lines (delayed- are a number of options that can be offered draw term loans) are credits that may be within a revolving credit line: drawn down for a given period to purchase •• A swingline is a small, overnight borrowing specified assets or equipment or to make line, typically provided by the agent. acquisitions. The issuer pays a fee during the •• A multicurrency line may allow the bor- commitment period (a ticking fee). The lines rower to borrow in several currencies. are then repaid over a specified period (the •• A competitive-bid option (CBO) allows bor- term-out period). Repaid amounts may not rowers to solicit the best bids from its syn- be reborrowed.

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Second-Lien Loans option of choice for small transactions, while Second-lien loans are another classic the high-yield bond market provided example of a U.S. import to the Europe subordinated financing for large deals. leveraged loan market. This asset class came However, mezzanine has extended its reach to Europe in 2004, but its U.S. history goes to include large deals, becoming a staple of back to the mid-1990s. These facilities fell LBO financings ranging in size from €10 out of favor after the Russian debt crisis million to €1 billion. caused investors to adopt a more cautious Mezzanine is popular with private equity tone. But after default rates fell precipitously groups because unlike public high-yield in 2003, arrangers in the U.S. rolled out bonds, it is a private instrument, syndicated second-lien facilities to help finance issuers to a group of lenders ranging from traditional struggling with liquidity problems. By 2005, shops that specialize in mezzanine to new the market had accepted second-lien loans investors, such as hedge funds. In addition to to finance a wide array of transactions, being subordinated debt, mezzanine includes including acquisitions and recapitalizations. a number of unique features. The interest However, second lien never served as consists of a cash and PIK margin above a rescue financing in Europe. By the time it base rate. Due to its secondary or tertiary reached this side of the Atlantic, it joined the position in the priority line, the total margin is ranks of mezzanine as a financing alternative considerably higher than on senior bank for private equity backed transactions, loans. In 2011, it ranged from from including buyouts and recapitalizations and Euribor+1,000 to Euribor+1,200, depending for a time it became almost an intrinsic part on the tranche’s size and credit quality, and of an LBO financing. on the level of appetite for mezzanine. As their name implies, the claims on In addition to spread, mezzanine has collateral of second-lien loans stand behind traditionally included warrants to provide those of first-lien loans but ahead of bonds lenders an unlimited upside potential should and mezzanine. the issuer perform well. Deals with warrants Unlike the U.S. (where second-lien loans carry lower spreads than those without them. also typically have less restrictive covenant Mezzanine often has a non-call provision, for packages in which maintenance covenant one to three years, plus prepayment penalties levels are set wider than the first-lien loans), at 102 bps and 101 bps in subsequent years. European second-lien credits share the same This also appeals to private equity groups covenant package as first-lien facilities. because when they decide to exit the Due to its secondary ranking in the priority company it will be cheaper to repay line, second-lien deals carry a spread mezzanine than high-yield bonds, which have premium over its first-lien counterparts. For longer non-call periods. example, during the market boom, the TLb/TLc This instrument carries the same financial tranches had an average spread of anywhere covenants as senior bank loans. Some from Euribor+275 to Euribor+325, while the facilities have identical covenant levels as average second lien is priced in the the first ranking debt while others include a Euribor+500 area. But pricing varied widely “haircut.” “Haircut” refers to how much depending on the complexity and riskiness of looser the mezzanine covenants are the underlying credit. Second-lien loans compared with senior debt. Usually this became much less common in the wake of the number is around 10%. 2007 credit crunch as investor appetite for The standard mezzanine standstill periods these tranches evaporated. By 2011, second- are either 60/90/120 days or 90/120/150 lien made rare appearances as arrangers days for mezzanine payment defaults/ searched for different pools of liquidity. financial covenant defaults/other mezzanine defaults, respectively. During the 2008/2009 credit crunch, mezzanine tranches were less Mezzanine Loans common in LBO structures as mezzanine A mezzanine loan is a subordinated funds sought much higher spreads—in the instrument that carries second-ranking mid- to high teens—on these tranches to security or third-ranking security if the compensate for losses on restructured deals. capital structure also includes second lien. Private equity subsequently switched to all- Historically, mezzanine has been a financing senior structures where possible, and also

A Guide To The European Loan Market february 2012 15 www.spcapitaliq.com began to make greater use of the high-yield Toggle Facilities bond market. Toggle facilities are primarily a by-product of hyper-liquid markets. They provide issuers Covenant-Lite Loans with a “pay if you want” feature that allows them to switch off any cash-pay element and Like second-lien loans, covenant-lite loans convert all spread to PIK without consulting are really just another type of syndicated loan the lending group. The toggle feature has facility. But they also are sufficiently different appeared on second- lien as well as to warrant their own section in this primer. At mezzanine facilities. the most basic level, covenant-lite loans are loans that have bond-like financial incurrence covenants rather than traditional Cross-Border Loans maintenance covenants that are normally Cross-border loans are transactions that are part and parcel of a loan agreement. syndicated simultaneously into multiple Incurrence covenants generally require markets. The most common cross-border that if an issuer takes an action (paying a transaction is one that is sold to both U.S. dividend, making an acquisition, issuing and European investors. However, cross- more debt), it would need to still be in borders can also be transactions sold in Asia compliance. So, for instance, an issuer that and the U.S., Asia and Europe, or even Asia, has an incurrence test that limits its debt the U.S., and Europe. to 5x cash flow would only be able to take The tranches that make up a cross-border on more debt if, on a pro forma basis, it loan are denominated in currencies to match was still within this constraint. If, not then the markets that they are being sold to. Thus, it would have breached the covenant and the U.S. portion of a cross-border will be be in technical default on the loan. If, on denominated in U.S. dollars and the European the other hand, an issuer found itself above portion will be denominated in euros. this 5x threshold simply because its For a cross-border transaction to be viable, earnings had deteriorated, it would not the issuer must have operations in all of the violate the covenant. markets that it is selling debt to. For Maintenance covenants are far more example, a traditionally U.S. issuer, such as restrictive. This is because they require an HCA Inc., must also have assets and/or issuer to meet certain financial tests every business in Europe to support a euro tranche quarter whether or not it takes an action. sold to European investors. So, in the case above, had the 5x leverage maximum been a maintenance rather than incurrence test, the issuer would need to Lender Titles pass it each quarter and would be in Lender titles in Europe reflect either the violation if either its earnings eroded or its banks’ position in the arrangement and debt level increased. For lenders, clearly, underwriting of the transaction or their maintenance tests are preferable because it administrative role. The MLA designation allows them to take action earlier if an remains the most significant lender title for issuer experiences financial distress. What’s the bank (or banks) providing the primary more, the lenders may be able to wrest arrangement and initial underwriting, and some concessions from an issuer that is in receiving the majority of fees. As the loan violation of covenants (a fee, incremental market has grown and matured, however, the spread, or additional collateral) in exchange array of other lender titles has proliferated. for a waiver. The largest lenders aside from the MLAs Conversely, issuers prefer incurrence are typically designated joint lead arrangers covenants precisely because they are less (JLA). The JLAs make the largest underwriting stringent. Covenant-lite loans, therefore, commitments and, in turn, receive the largest thrive only in the hottest markets when the fees. Titles assigned during general supply/ demand equation is tilted syndication include arranger, co-arranger, and persuasively in favor of issuers. lead manager. These titles have become Covenant-lite loans made only a brief largely ceremonial, routinely awarded for what appearance in the European market, and amounts to no more than large retail disappeared with the credit crunch. commitments in exchange for upfront fees.

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The primary administrative title is that of agents in the U.S. started to break out bookrunner (or joint bookrunner when there is specific assignment minimums for more than one bank involved). The bookrunner institutional tranches, and Europe has since role is almost always assigned to the MLA(s) done likewise, typically setting the minimum and it takes on the administrative tasks size at €1 million-€2.5 million. generally associated with the administrative agent and syndication in the U.S. Participations The other administrative titles seen A participation is an agreement between an regularly in the European market are the existing lender and a participant. As the facility agent and security agent. name implies, it means the buyer is taking a The facility agent administers the participating interest in the existing lender’s syndicate, keeping track of syndicate commitment. members’ commitments, repayments, The lender remains the official holder of secondary trades, and also handling the loan, with the participant owning the alterations to documentation via waivers. rights to the amount purchased. Consents, The security agent oversees the fees, or minimums are almost never required. management of the underlying security, The participant has the right to vote only on particularly with regards to the intercreditor material changes in the loan document (rate, agreement and guarantees. This role occurs term, and collateral). Nonmaterial changes primarily only in the case of complex do not require approval of participants. A security packages. participation can be a riskier way of purchasing a loan, because, if a lender becomes insolvent or defaults, the Secondary Sales participant does not have a direct claim on Secondary sales occur after the loan is the loan. In this case, the participant then closed and allocated, when investors are free becomes a creditor of the lender and often to trade the paper. Loan sales are structured must wait for claims to be sorted out to as either assignments or participations, with collect on its participation. investors usually trading through dealer Sub-participations are also a mechanism desks at the large underwriting banks. for transferring paper in Europe. In the case Dealer-to-dealer trading is almost always of a sub-participation, the participant has no conducted through a “street” broker. right to vote as its position in the lending The secondary market in Europe is less group is only based on its agreement with the liquid than in the U.S. Bank lenders typically lender of record. do not trade in secondary, but the influx of institutional investors in 2005-2007 drove rapid growth in secondary activity, amid Loan Derivatives hyper liquid conditions. In mid-2007, that Loan credit default swaps secondary liquidity contracted once again, Traditionally, accounts bought and sold loans and the market remained illiquid throughout in the cash market through assignments and 2008-2011. participations. Aside from that, there was little synthetic activity outside over-the- Assignments counter total rate of return swaps. By 2008, In an assignment, the assignee becomes a however, the market for synthetically trading direct signatory to the loan and receives loans was budding. interest and principal payments directly from Loan credit default swaps (LCDS) are the administrative agent. standard derivatives that have secured loans Assignments typically require the consent as reference instruments. In June 2006, The of the borrower and agent. Consent may be International Settlement and Dealers withheld only if a reasonable objection is Association issued a standard trade made and the borrower frequently loses its confirmation for LCDS contracts. right to consent in the event of default. Like all credit default swaps (CDS), an The loan document usually sets a LCDS is basically an insurance contract. minimum assignment amount, usually €2.5 The seller is paid a spread in exchange for million-€5 million for pro rata commitments. agreeing to buy at par, or a prenegotiated In the late 1990s, however, administrative price, a loan if that loan defaults. LCDS

A Guide To The European Loan Market february 2012 17 www.spcapitaliq.com enables participants to synthetically buy a index that is still active. The index will be set loan by going short the CDS or to sell the loan at an initial spread based on the reference by going long the CDS. Theoretically, then, a instruments and trade on a price basis. loanholder can hedge a position either According to the primer posted by Markit directly (by buying CDS protection on that (http://www.markit.com/information/ specific name) or indirectly (by buying affiliations/lcdx/alertParagraphs/01/ protection on a comparable name or basket document/ LCDX%20Primer.pdf), “The two of names). events that would trigger a payout from the Moreover, unlike the cash markets, which buyer (protection seller) of the index are are long-only markets for obvious reasons, bankruptcy or failure to pay a scheduled the CDS market provides a way for investors payment on any debt (after a grace period), to short a loan. To do so, the investor would for any of the constituents of the index.” buy protection on a loan that it doesn’t hold. All documentation for the index is posted If the loan subsequently defaults, the buyer at: http://www.markit.com/information/ of protection should be able to purchase the affiliations/l cdx/alertParagraphs/01/ loan in the secondary market at a discount document/LCDX%20Primer.pdf. and then deliver it at par to the counterparty from which it bought the LCDS contract. For Total rate-of-return swaps instance, say an account buys five-year This is the oldest way for participants to protection for a given loan, for which it pays purchase loans synthetically. And, in reality, a 250 bps per year. Then in year two the loan total rate-of-return swap (TRS) is little more goes into default and the market price falls to than buying a loan on margin. In simple 80% of par. The buyer of the protection can terms, under a TRS program a participant then buy the loan at 80 and deliver to the buys the income stream created by a loan counterpart at 100, a 20-point pickup. Or from a counterparty, usually a dealer. The instead of physical delivery, some buyers of participant puts down some percentage as protection may prefer a cash settlement in collateral, say 10%, and borrows the rest which the difference between the current from the dealer. Then the participant receives market price and the delivery price is the spread of the loan minus the financial determined by polling dealers or using a cost plus LIBOR on its collateral account. If third-party pricing service. Cash settlement the reference loan defaults, the participant could also be used if there’s not enough must buy it at par or cash settle the loss paper to physically settle all LCDS contracts based on a mark-to-market price or an on a particular loan. auction price. Here is how the economics of a TRS work, in simple terms. A participant buys via a TRS LCDX/LevX a $10 million position in a loan paying L+250. Introduced in 2006, the LevX is an index of To effect the purchase, the participant puts 40 senior first-lien LCDS obligations that $1 million in a collateral account and pays participants can trade. The index provides a L+50 on the balance (meaning leverage of straightforward way for participants to take 9:1). Thus, the participant would receive: long or short positions on a broad basket of •• L+250 on the amount in the collateral loans, as well as to hedge their exposure to account of $1 million, plus the market. A subordinated version of LevX •• 200 bps (L+250 less the borrowing cost was also established. However, both indices of L+50) on the remaining amount of gradually became illiquid in the aftermath of $9 million. the 2007 credit crunch and trading became The resulting income is LIBOR+250 times very rare. $1 million plus 200 bps times $9 million. Introduced in 2007 in the U.S., LCDX is an Based on the participants’ collateral index of 100 LCDS obligations. amount—or equity contribution—of $1 Markit Group administers the LCDX, a million, the return is L+2020. If LIBOR is 5%, product of CDS Index Co., a firm set up by a the return is 25.5%. Of course, this is not a group of dealers. Like LCDS, the LCDX Index is risk-free proposition. If the issuer defaults an over-the-counter product. and the value of the loan goes to 70 cents on The LCDX is reset every six months, with the euro, the participant will lose $3 million. participants able to trade each vintage of the And, if the loan does not default but is marked

18 Leveraged commentary & data february 2012 www.spcapitaliq.com A Primer For The European Syndicated Loan Market

down for whatever reason—market spreads 3% LIBOR floor and three-month LIBOR falls widen, it is downgraded, its financial condition below this level, the base rate for any resets deteriorates—the participant stands to lose default to 3%. For obvious reasons, LIBOR the difference between par and the current floors are generally seen during periods when market price when the TRS expires. Or, in an market conditions are difficult and rates are extreme case, the value declines below the falling as an incentive for lenders. LIBOR value in the collateral account and the floors are much more common in the U.S, participant is hit with a margin call. than they are in Europe, but a number of cross-border deals do include this feature.

Pricing Terms Fees Rates The fees associated with syndicated loans Loans usually offer borrowers different are the upfront fee, the commitment fee, interest-rate options. Several of these the facility fee, the administrative agent fee, options allow borrowers to lock in a given rate the LOC fee, and the cancellation or for one month to one year. Pricing on many prepayment fee. loans is tied to performance grids, which An arranger fee is the fee paid by the issuer adjust pricing by one or more financial to the arranger for the service it provides in criteria. Pricing is typically tied to ratings in underwriting and arranging the debt. This will investment-grade loans and to financial be a one-time, upfront payment. ratios in leveraged loans. An upfront fee is a fee paid by the issuer Syndication pricing options are either a at close. It is often tiered, with the lead broad LIBOR, CD, and other fixed rate options: arranger receiving a larger amount in •• The prime is a floating-rate option. consideration for structuring and/or Borrowed funds are priced at a spread over underwriting the loan. Co-underwriters will the reference bank’s prime lending rate. receive a lower fee, and then the general The rate is reset daily, and borrowings may syndicate will likely have fees tied to their be repaid at any time without penalty. This commitment. Most often, fees are paid on a is typically an overnight option, because lender’s final allocation. For example, a loan the prime option is more costly to the bor- has two fee tiers: 100 bps (or 1%) for $25 rower than LIBOR or CDs. million commitments and 50 bps for $15 Euribor rate or a local currency base option: million commitments. A lender committing •• The Euribor option is so called because, to the $25 million tier will be paid on its final with this option, the interest on borrow- allocation rather than on initial ings is set at a spread over Euribor for a commitment, which means that, in this period of one month to one year. The cor- example, the loan is oversubscribed and responding Euribor rate is used to set lenders committing $25 million would be pricing. Borrowings cannot be prepaid allocated $20 million and the lenders would without penalty. receive a fee of $200,000 (or 1% of $20 •• Local currency options. Facilities can fund million). Sometimes upfront fees will be in a number of currencies other than the structured as a percentage of final euro, particularly the U.S. dollar and the allocation plus a flat fee. This happens most British pound. U.S. dollar- and sterling- often for larger fee tiers, to encourage denominated tranches will generally use potential lenders to step up for larger their respective LIBORs as the base rate. commitments. The flat fee is paid regardless Tranches denominated in other local cur- of the lender’s final allocation. Fees are rencies, such as the Swiss franc or the usually paid to banks, mutual funds, and Swedish krona, can float over a local money other non-offshore investors at close. CLOs market base rate, but usually also provide a and other offshore vehicles are typically further option to fund in a more common brought in after the loan closes as a currency such as the euro or the U.S. dollar “primary” assignment, and they simply buy and will thus use the relevant base rate. the loan at a discount equal to the fee offered in the primary assignment, for LIBOR floors tax purposes. As the name implies, LIBOR floors put a floor A commitment fee is a fee paid to lenders under the base rate for loans. If a loan has a on undrawn amounts, under a revolving

A Guide To The European Loan Market february 2012 19 www.spcapitaliq.com credit or a term loan before draw-down. On always 12.5 bps to 25 bps (0.125% to 0.25%) term loans, this fee is sometimes referred to of the LOC commitment. as a “ticking” fee. A facility fee, which is paid on a facility’s Original issue discounts (OID) entire committed amount, regardless of This is yet another term imported from the usage, may be charged instead of a bond market. The OID is the discount from commitment fee on revolving credits to par at which a loan is offered in the new issue investment-grade borrowers. market as a spread enhancement. A loan may A usage fee is a fee paid when the be issued at 99 to pay par. The OID in this utilization of a revolving credit falls below a case is said to be 100 bps, or 1 point. certain minimum. These fees are applied mainly to investment-grade loans and OID versus upfront fees generally call for fees based on the utilization At this point, the careful reader may be won- under a revolving credit. In some cases, the dering just what the difference is between an fees are for high use and, in some cases, for OID and an upfront fee. After all, in both low use. Often, either the facility fee or the cases the lender effectively pays less than spread will be adjusted higher or lower based par for a loan. on a preset usage level. From the perspective of the lender, A prepayment fee is a feature generally actually, there isn’t much of a difference. But associated with institutional term loans. This for the issuer and arrangers, the distinction fee is seen mainly in weak markets as an is far more than semantics. Upfront fees are inducement to institutional investors. Typical generally paid from the arrangers prepayment fees will be set on a sliding underwriting fee as an incentive to bring scale; for instance, 2% in year one and 1% in lenders into the deal. An issuer may pay the year two. The fee may be applied to all arranger 2% of the deal and the arranger, to repayments under a loan or “soft” rally investors, may then pay a quarter of this repayments, those made from a refinancing amount, or 0.5%, to the lender group. or at the discretion of the issuer (as opposed An OID, however, is generally borne by the to hard repayments made from excess cash issuer, above and beyond the arrangement flow or asset sales). fee. So the arranger would receive its 2% fee An administrative agent fee is the annual and the issuer would only receive 99 cents for fee typically paid to administer the loan every dollar of loan sold. (including to distribute interest payments to For instance, take a $100 million loan the syndication group, to update lender lists, offered at a 1% OID. The issuer would receive and to manage borrowings). For secured $99 million, of which it would pay the loans (particularly those backed by arrangers 2%. The issuer then would be receivables and inventory), the agent often obligated to pay back the whole $100 million, collects a collateral monitoring fee, to ensure even though it received $97 million after fees. that the promised collateral is in place. Now, take the same $100 million loan offered An LOC fee can be any one of several types. at par with an upfront fee of 1%. In this case, The most common—a fee for standby or the issuer gets the full $100 million. In this financial LOCs—guarantees that lenders will case, the lenders would buy the loan not at support various corporate activities. Because par, but at 99 cents on the dollar. The issuer these LOCs are considered “borrowed funds” would receive $100 million of which it would under capital guidelines, the fee is typically pay 2% to the arranger, which would then pay the same as the Euribor margin. Fees for one-half of that amount to the lending group. commercial LOCs (those supporting inventory The issuer gets, after fees, $98 million. or trade) are usually lower, because in these Clearly, OID is a better deal for the arranger cases actual collateral is submitted). The LOC and, therefore, is generally seen in more is usually issued by a fronting bank (usually challenging markets. Upfront fees, the agent) and syndicated to the lender conversely, are more issuer friendly and group on a pro rata basis. The group receives therefore are staples of better market the LOC fee on their respective shares, while conditions. Of course, during the most the fronting bank receives an issuing (or muscular bull markets, new-issue paper is fronting, or facing) fee for issuing and generally sold at par and therefore requires administering the LOC. This fee is almost neither upfront fees nor OIDs.

20 Leveraged commentary & data february 2012 www.spcapitaliq.com A Primer For The European Syndicated Loan Market

Voting Rights Agreements to leveraged borrowers are Amendments or changes to a loan agreement often much more onerous. must be approved by a certain percentage of The three primary types of loan covenants lenders. Most loan agreements have three are affirmative, negative, and financial. levels of approval: required-lender level, full Affirmative covenants state what action vote, and supermajority: the borrower must take to comply with the •• The “required-lenders” level, usually just a loan, such as that it must maintain simple majority, is used for approval of insurance. These covenants are usually nonmaterial amendments and waivers or boilerplate and require a borrower to pay the changes affecting one facility within a deal. bank interest and fees, maintain insurance, •• A full vote of all lenders, including partici- pay taxes, and so forth. pants, is required to approve material Negative covenants limit the borrower’s changes such as RATS (rate, amortization, activities in some way, such as regarding term, and security; or collateral) rights, new investments. Negative covenants, but, as described below, there are occa- which are highly structured and customized sions when changes in amortization and to a borrower’s specific condition, can limit collateral may be approved by a lower per- the type and amount of investments, new centage of lenders (a supermajority). debt, liens, asset sales, acquisitions, •• A supermajority is typically 67% to 80% of and guarantees. lenders and is sometimes required for cer- Financial covenants enforce minimum tain material changes such as changes in financial performance measures against the amortization (in-term repayments) and borrower, such as that he must maintain a release of collateral. Used periodically in higher level of current assets than of the U.S. in the mid-1990s, these provisions current liabilities. The presence of these fell out of favor by the late 1990s. In maintenance covenants—so called because Europe it is still commonly seen for mate- the issuer must maintain quarterly rial changes, simply known as “majority.” compliance or suffer a technical default on •• The “Yank The Bank” clause provides for the loan agreement—is a critical difference the replacement of a minority nonconsent- between loans and bonds. ing lender where the majority of lenders Bonds and covenant-lite loans (see above), are in agreement. In Europe, this is gener- by contrast, usually contain incurrence ally only seen in LBO transactions. covenants that restrict the borrower’s ability •• The “You Snooze, You Lose” clause to issue new debt, make acquisitions, or take excludes from the final calculation any other action that would breach the covenant. lender who fails to reply in a timely fashion For instance, a bond indenture may require to an amendment request. the issuer to not incur any new debt if that new debt would push it over a specified ratio of debt to EBITDA. But, if the company’s cash Covenants flow deteriorates to the point where its debt Loan agreements have a series of to EBITDA ratio exceeds the same limit, a restrictions that dictate, to varying degrees, covenant violation would not be triggered. how borrowers can operate and carry This is because the ratio would have climbed themselves financially. For instance, one organically rather than through some action covenant may require the borrower to by the issuer. maintain its existing fiscal-year end. As a borrower’s risk increases, financial Another may prohibit it from taking on new covenants in the loan agreement become debt. Most agreements also have financial- more tightly wound and extensive. In general, compliance covenants, for example, that a there are five types of financial covenants— borrower must maintain a prescribed level coverage, leverage, current ratio, tangible net of equity, which, if not maintained, gives worth, and maximum capital expenditures: banks the right to terminate the agreement •• A coverage covenant requires the borrower or push the borrower into default. The size to maintain a minimum level of cash flow of the covenant package increases in or earnings, relative to specified expenses, proportion to a borrower’s financial risk. most often interest, debt service (interest Agreements to investment-grade and repayments), fixed charges (debt ser- companies are usually thin and simple. vice, capex, and/or rent).

A Guide To The European Loan Market february 2012 21 www.spcapitaliq.com •• A leverage covenant sets a maximum level •• Equity issuance is defined as the net pro- of debt, relative to either equity or cash ceeds of equity issuance. The typical per- flow, with the debt-to-cash-flow level centage required is 50% to 100%. being far more common. Often, repayments from excess cash flow •• A current-ratio covenant requires that the and equity issuance are waived or relaxed if borrower maintain a minimum ratio of the issuer meets a preset financial hurdle, current assets (cash, marketable securi- most often structured as a debt/EBITDA test. ties, accounts receivable, and inventories) to current liabilities (accounts payable, Collateral and other protective loan provisions short-term debt of less than one year), In the leveraged market, collateral usually but sometimes a “quick ratio,” in which includes all the tangible and intangible assets inventories are excluded from the of the borrower and, in some cases, specific numerator, is substituted. assets that back a loan. •• A tangible-net-worth (TNW) covenant Virtually all leveraged loans and some requires that the borrower have a mini- weaker investment-grade credits are backed mum level of TNW (net worth less intan- by pledges of collateral. In the asset-based gible assets, such as goodwill, market, for instance, that typically takes the intellectual assets, excess value paid for form of inventories and receivables, with the acquired companies), often with a build- amount of the loan tied to a formula based up provision, which increases the mini- on the value of these assets. A common rule mum by a percentage of net income is that an issuer can borrow against 50% of or equity issuance. inventory and 80% of receivables. Naturally, •• A maximum-capital-expenditures covenant there are loans backed by certain equipment, requires that the borrower limit capital real estate, and other property. expenditures (purchases of property, plant, In the leveraged market, there are some and equipment) to a certain amount, which loans that are backed by capital stock of may be increased by some percentage of operating units. In this structure, the assets cash flow or equity issuance, but often of the issuer tend to be at the operating- allowing the borrower to carry forward company level and are unencumbered by unused amounts from one year to the next. liens, but the holding company pledges the Some transactions include terms geared to stock of the operating companies to the diminish the impact of covenant testing: lenders. This effectively gives lenders control •• A mulligan essentially allows the borrower of these units if the company defaults. The a “do-over” on the covenant tests. If, for risk to lenders in this situation, simply put, is example, a company does not comply that a bankruptcy court collapses the with its covenants for one quarter but is holding company with the operating back in line the following quarter, the companies and effectively renders the stock previous quarter is disregarded as if it worthless. In these cases, loan holders never happened. become unsecured lenders of the company and are put back on the same level with Mandatory prepayments other senior unsecured creditors. Leveraged loans usually require a borrower to prepay with proceeds of excess cash flow, Springing liens/collateral release asset sales, debt issuance, or equity issuance. Some loans have provisions that borrowers •• Excess cash flow is typically defined as that sit on the cusp of investment-grade cash flow after all cash expenses, required and speculative-grade must either attach dividends, debt repayments, capex, and collateral or release it if the issuer’s changes in working capital. The typical rating changes. percentage required is 50% to 75%. A ‘BBB’ or ‘BBB-’ issuer may be able to •• Asset sales are defined as net proceeds of convince lenders to provide unsecured asset sales, normally excluding receivables financing, but lenders may demand springing or inventories. The typical percentage liens if the issuer’s credit quality deteriorates. required is 100%. Often, an issuer’s rating being lowered to •• Debt issuance is defined as net proceeds ‘BB+’ or exceeding its predetermined from debt issuance. The typical percentage leverage level will trigger this provision. required is 100%. Likewise, lenders may demand collateral from

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a strong, speculative-grade issuer, but will intercreditor agreement is an agreement to offer to release under certain circumstances, subordination and stipulates the priority of such as if the issuer gains an investment- repayment to all lenders, senior and grade rating. subordinated, in the case of default. It applies to lenders across borders and codifies their Change of control positions in the absence of intervention from Invariably, one of the events of default in a individual bankruptcy courts. credit agreement is a change of issuer control. Similarly, cross-guarantees ensure that For both investment-grade and leveraged the varied operating units associated with a issuers, an event of default in a credit borrower guarantee its assets as collateral. agreement will be triggered by a merger, an Thus, should one part trigger a default, all the acquisition of the issuer, some substantial associated companies will be equally purchase of the issuer’s equity by a third responsible and their assets will be available party, or a change in the majority of the for repayment. board of directors. For sponsor-backed The fixed and floating liens are another leveraged issuers, the sponsor’s lowering its type of guarantee from operating units of the stake below a preset amount can also trip borrower. This type of guarantee balances the this clause. need of the borrower to have the ability to actively manage its business with regards to Equity cures acquiring and disposing of assets with that of These provisions allow issuers to fix a the lender to have claim to those assets in covenant violation—exceeding the maximum the case of underperformance or default. The debt to EBITDA test for instance—by making terms of this guarantee essentially allow the an equity contribution. These provisions are borrower to dispose of assets without generally found in private equity-backed consent (thus the floating aspect). However, deals, giving the sponsor the right, but not the proceeds must go through certain the obligation, to inject equity and cure a channels, including certain designated violation without having to request a waiver accounts, so that the borrower has the right or amendment. The equity cure is a right, not to freeze those assets (fixing them) under an obligation. Therefore, a private equity firm certain circumstances. will want these provisions, which, if they think it’s worth it, allows them to cure a violation Asset-Based Lending without going through an amendment Most of the information above refers to process, through which lenders will often ask “cash flow” loans, loans that may be for wider spreads and/or fees in exchange for secured by collateral, but are repaid by cash waiving the violation even with an infusion of flow. Asset-based lending is a distinct new equity. Some agreements do not limit segment of the loan market. These loans are the number of equity cures, while others cap secured by specific assets and usually the number to, say, one per year or two over governed by a borrowing formula (or a the life of the loan, with the exact details “borrowing base”). The most common type negotiated for each deal. Bull markets tend of asset-based loans are receivables and/or to bring more generous equity cures as part inventory lines. These are revolving credits of looser overall documentation, while in bear that have a maximum borrowing limit, say markets documentation is tighter and equity $100 million, but also have a cap based on cures are less easily available. the value of an issuer’s pledged receivables and inventories. Usually, the receivables are Intercreditor agreements and cross-guarantees pledged and the issuer may borrow against European borrowers tend to have more 80%, give or take. Inventories are also often complex corporate structures than U.S. firms pledged to secure borrowings. However, due to the multijurisdictional nature of the because they are obviously less liquid than eurozone, as well as the prevalence of private receivables, lender advance rates are less equity management. As a result, intercreditor generous. Indeed, the borrowing base for agreements and cross-guarantees are inventories is typically in the 50% to 65% significant parts of ensuring lender rights range. In addition, the borrowing base may regarding a loan transaction particularly with be further divided into subcategories—for regards to underperformance or default. The

A Guide To The European Loan Market february 2012 23 www.spcapitaliq.com instance, 50% of work-in-process inventory Default And Restructuring and 65% of finished goods inventory. There are two primary types of loan In many receivables-based facilities, defaults: technical defaults and the much issuers are required to place receivables in a more serious payment defaults. Technical “lock box.” That means that the bank lends defaults occur when the issuer violates a against the receivable, takes possession of it, provision of the loan agreement. For and then collects it to pay down the loan. instance, if an issuer does not meet a In addition, asset-based lending is often financial covenant test or fails to provide done based on specific equipment, real lenders with financial information or estate, car fleets, and an unlimited number of some other violation that doesn’t other assets. involve payments. When this occurs, the lenders can Subsidiary guarantees accelerate the loan and force the issuer into Though not collateral in the strict sense of bankruptcy. That is the most extreme the word, most leveraged loans are backed measure and rarely employed. In many cases, by the guarantees of subsidiaries so that if the issuer and lenders are able to agree on an issuer goes into bankruptcy all of its units an amendment that waives the violation in are on the hook to repay the loan. This is exchange for a fee, spread increase, and/or often the case, too, for unsecured tighter terms. investment-grade loans. A payment default is a more serious matter. As the term implies, this type of Negative pledge default occurs when a company misses This is also not a literal form of collateral, but either an interest or principal payment. most issuers agree not to pledge any assets There is often a pre-set period of time, say to new lenders to ensure that the interests of 30 days, during which an issuer can cure a the loan holders are protected. default (the “cure period”). After that, the lenders can choose to either provide a Loan math—the art of spread calculation forbearance agreement that gives the Calculating loan yields or spreads is not issuer some breathing room or take straightforward. Unlike most bonds, which appropriate action, up to and including have long no-call periods and high-call accelerating, or calling, the loan. premiums, most loans are prepayable at If the lenders accelerate, the company will any time typically without prepayment fees. generally declare bankruptcy and restructure And, even in cases where prepayment fees its debt. If the company is not worth saving, apply, they are rarely more than 2% in year however, because its primary business has one and 1% in year two. Therefore, affixing cratered, then the issuer and lenders may be a spread- to-maturity or a spread-to- forced into liquidation in which the assets of worst on loans is little more than a the business are sold and the proceeds theoretical calculation. dispensed to the creditors. In this case, This is because an issuer’s behavior is jurisdictional issues abound in the European unpredictable. It may repay a loan early loan market as most borrowers have because a more compelling financial operations in a multitude of countries. opportunity presents itself or because the Additionally, each jurisdiction may treat issuer is acquired or because it is making an lender seniority differently. acquisition and needs a new financing. Traders and investors will often speak of loan spreads, Amend-To-Extend therefore, as a spread to a theoretical call. Loans, on average, between 1997 and 2004 This technique allows an issuer to push out had a 15-month average life. So, if you buy a part of its loan maturities through an loan with a spread of 250 bps at a price of amendment, rather than a full refinancing. 101, you might assume your spread-to-expect Amend-to-extend transactions appeared in life as the 250 bps less the amortized 100 bps 2009 as borrowers struggled to push out premium or LIBOR+170. Conversely, if you maturities in the face of difficult lending bought the same loan at 99, the spread-to- conditions that made refinancing expect life would be LIBOR+330. prohibitively expensive.

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Amend-to-extend transactions have two Sub-Par Loan Buybacks phases, as the name implies. The first is an This is another technique that grew out of the amendment in which at least 50.1% of the bear market that began in 2007. Performing bank group approves the issuer’s ability to paper fell to levels not seen before in the loan roll some or all existing loans into longer- market, with many trading south of 70. This dated paper. Typically, the amendment sets created an opportunity for borrowers with the a range for the amount that can be financial wherewithal and the covenant tendered via the new facility, as well as headroom to repurchase loans via a tender, or the spread at which the longer-dated in the open market, at prices below par. paper will pay interest. Sub-par buybacks have deep roots in the The new debt is pari passu with the bond market. Loans didn’t suffer the price existing loan. But because it matures later declines before 2007 to make such tenders and, thus, is structurally subordinated, it attractive, however. In fact, most loan carries a higher rate, and, in some cases, documents do not provide for a buyback. more attractive terms. Because issuers with Instead, issuers typically need obtain lender big debt loads are expected to tackle debt approval via a 50.1% amendment. maturities over time, amid varying market conditions, in some cases, accounts insist Distressed exchanges on most-favored-nation protection. Under This is a negotiated tender in which class- such protection, the spread of the loan holders will swap their existing paper for a would increase if the issuer in question new series of bond that typically have a lower prints a loan at a wider margin. principal amount and, often, a lower yield. In The second phase is the conversion, in exchange the bondholders might receive which lenders can exchange existing loans for stepped-up treatment, going from subordi- new loans. In the end, the issuer is left with nated to senior, say, or from unsecured to two tranches: (1) the legacy paper at the initial second-lien. price and maturity and (2) the new facility at a Standard & Poor’s consider these wider spread. The innovation here: amend-to- programs a default and, in fact, the holders extend allows an issuer to term-out loans are agreeing to take a principal haircut to without actually refinancing into a new credit allow the company to remain solvent and (which obviously would require marking the improve its ultimate recovery prospects. entire loan to market, entailing higher spreads, This technique is used frequently in the a new OID, and stricter covenants). bond market but rarely for first-lien loans. l

A Guide To The European Loan Market february 2012 25 www.spcapitaliq.com Glossary

Amend-to-extend (A-to-E). This technique al- use its own equity to purchase the debt. lows an issuer to push out part of its loan ma- Loan Market Association guidelines sug- turities through an amendment, rather than gest the company should tender for its debt a full refinancing. A-to-E transactions have via a transparent auction process, as well two phases, as the name implies. The first is as suggesting measures to reduce the risk an amendment in which at least 50.1% of the of a conflict of interests resulting from the bank group approves the issuer’s ability to roll sponsor owning debt and equity. Although some or all existing loans into longer-dated buybacks reduce the company’s debt burden, paper. The second phase is the conversion, they are often contentious, especially if done in which lenders can exchange existing loans using surplus cash rather than equity, and in for new loans. In the end, the issuer is left some cases lenders refuse to sign waivers to with two tranches: (1) the legacy paper at give their permission. the initial price and maturity and (2) the new BWIC. An acronym for “bids wanted in competi- facility at a wider spread. tion.” It’s really just a fancy way of describing a Arranger fee. The fee paid by the issuer to secondary auction of loans or bonds. Typically the arranger for arranging and underwriting an account will offer up a portfolio of facilities a loan. via a dealer. The dealer will then put out a BWIC, Asset sales prepayment. The prepayment asking potential buyers to submit for individual required as a result of the net proceeds of names or the entire portfolio. The dealer will asset sales, normally excluding receivables or then collate the bids and award each facility to inventories. The typical percentage required the highest bidder. is 100%. Circled. When a loan or bond is full sub- Assignment minimum. The amount that the scribed at a given price it is said to be circled. lender can assign to a different lender. It After that, the loan or bond moves to allocation ranges from €1 million to €5 million. and funding. Axe sheets. These are sheets with lists of Club deal. A smaller loan (usually €50-150 secondary bids and offers for loans that million, but as high as €300 million) that is dealers send to accounts. Axes are simply premarketed to a group of relationship lend- price indications. ers. The arranger is generally a first among Bank book (information memo). This docu- equals, and each lender gets a full cut, or ment, prepared by the arranging bank, nearly a full cut, of the fees. Club deals are describes the transaction’s terms. The bank traditionally rare from the perspective of book, or IM, typically will include an executive transactions syndicated across regions, but summary, investment considerations, a list they are common regional plays in Europe, of terms and conditions, an industry over- where regional banks provide the funding. view, and a financial model. Because loans Commitment fee. A fee paid on unused portion are not securities, this will be a confidential of the facility that ranges from 50 to 75 bps. offering made only to qualified banks and For example, the company might have a €100 accredited investors. million revolving credit, but it only needs to Break price. Price on the facility at the mo- draw €20 million; it must pay a fee on the ment it goes free to trade in the secondary remaining €80 million to compensate the market once allocations are made or how lenders for keeping this money available. much investors are willing to pay for this deal Corporate LBO. A buyout of a company by a if they would like to hold it. When the market private equity firm from a corporation. It’s is strong and the transaction is well received, also called corporate divestiture. the break price generally will be above par. Covenant-lite. Loans that have bond-like Buyback. In a buyback, a sponsor or company financial incurrence covenants rather than will opportunistically buy back the company’s traditional maintenance covenants that are debt out of the secondary market, typically normally part and parcel of a loan agreement. taking advantage of depressed secondary Cover bid. The level that a dealer agrees to prices. The issuer might use surplus cash essentially underwrite a BWIC or an auction. off its balance sheet or the sponsor might The dealer, to win the business, may give an

26 Leveraged commentary & data february 2012 www.spcapitaliq.com Glossary

account a cover bid, effectively putting a floor elusive art (see above) and therefore a more on the auction price. pedestrian price measure is used. Credit statistics. Financial ratios, such as EBITDA. Earnings before interest, taxes, leverage ratio, interest coverage ratio, etc. depreciation, and amortization. This is often Cross border. A transaction syndicated to used as a proxy for cash flow. both U.S. and European investors. Equity contribution. How much money the Deal size. Total amount of bank debt raised sponsor put in to finance the transaction. for the transaction. Calculated as the sponsor’s equity amount Default rate. Calculated by either number divided by total transaction amount. of loans or principal amount. The formula is Equity cure. These provisions allow issuers similar. For default rate by number of loans: to fix a covenant violation—exceeding the the number of loans that default over a given maximum debt to EBITDA test for instance— 12-month period divided by the number of by making an equity contribution. These loans outstanding at the beginning of that provisions are generally found in private period. For default rate by principal amount: equity-backed deals, giving the sponsor the the amount of loans that default over a right, but not the obligation, to inject equity 12-month period divided by the total amount and cure a violation without having to request outstanding at the beginning of the period. a waiver or amendment. Some agreements Standard & Poor’s defines a default for the do not limit the number of equity cures, while purposes of calculating default rates as a others cap the number to, maybe one per year loan that is either: or two over the life of the loan, with the exact •• Rated ’D’ by Standard & Poor’s, details negotiated for each deal. Bull markets •• Made to an issuer that has filed tend to bring more generous equity cures as for bankruptcy, part of looser overall documentation, while in •• In payment default on interest or principal, or bear markets documentation is tighter and •• Restructured in such a way as to create a equity cures are less easily available. material loss to the lender. Equity issuance prepayment. The prepayment Default. There are two primary types of loan required as a result of the net proceeds of eq- defaults, technical defaults and the much uity issuance. The typical percentage required more serious payment defaults. Technical is 50% to 100%. defaults occur when the issuer violates a Excess cash flow prepayment. The prepayment provision of the loan agreement. For instance, required as a result of excess cash flow which if an issuer doesn’t meet a financial covenant is typically defined as cash flow after all cash test or fails to provide lenders with financial expenses, required dividends, debt repay- information or some other violation that ments, capital expenditures and changes doesn’t involve payments. A payment default, in working capital. The typical percentage as the name implies, happens when a com- required is 50% to 75%. pany misses either an interest or principal Financial covenant. Financial covenants payment. There is often a preset period, say enforce minimum financial performance 30 days, during which an issuer can cure a measures against the borrower, for instance default (the “cure” or “grace” period). After to maintain a higher level of current assets that, the lenders can take appropriate action, than current liabilities. As a borrower’s risk up to and including accelerating, or calling, increases, these covenants become more the loan. restrictive and extensive. Disintermediation. Disintermediation refers to First-lien debt. Senior debt that holds the first the process whereby banks are replaced (or priority on security. disintermediated) by institutional investors. Flex. Margin flex language allows the arranger Distressed loans. In the loan market, loans to change spreads during syndication to traded at less than 80 cents on the dollar adjust pricing to current liquidity levels. To were traditionally considered distressed, entice more investors into buying the credit, although in 2007-2008 some performing spreads will be raised, or “flexed up.” When loans traded in the 80s and below due to liquidity is high and demand outstrips supply, technical rather than fundamental weakness. the spread will be decreased, or “reverse In the bond market, the common definition flexed.” A structural flex occurs when the is a spread of 1,000 bps or more. In the loan arranger adjusts the size of tranches during market, however, calculating spreads is an syndication to reflect current liquidity levels.

A Guide To The European Loan Market february 2012 27 www.spcapitaliq.com As a result, during highly liquid times, an ar- Some participants use a spread cut-off: i.e., ranger may move debt from the more expen- any loan with a spread of Euribor + 125 or sive tranches, such as mezzanine, to cheaper Euribor + 150 or higher qualifies. Others use tranches, such as second lien or first lien. rating criteria: i.e., any loan rated ‘BB+’ or Forward calendar. A list of loans or bonds that lower qualifies. But what of loans that are not have been announced but not yet launched rated? At Standard & Poor’s Leveraged Com- via a general syndication bank meeting. In the mentary & Data, we have developed a more U.S., this is a list of loans or bonds that have complex definition. We include a loan in the been announced but not yet closed, includ- leveraged universe if it is rated ‘BB+’ or lower ing both instruments that are yet to come or it is not rated or rated ‘BBB-‘ or higher but to market as well as those that are actively has (1) a spread of Euribor + 125 or higher and being sold but have yet to be circled. (2) is secured by a first or second lien. Under Haircut. In relationship to financial covenants, this definition, a loan rated ‘BB+’ that has a this refers to the looser maintenance cov- spread of Euribor + 75 would qualify, but a enants set for mezzanine tranches compared nonrated loan with the same spread would not. with senior credit. It is hardly a perfect definition, but one that Implied ratings (credit estimates or shadow Standard & Poor’s thinks best captures the rating). Credit opinions that are not available spirit of loan market participants when they publicly on Standard & Poor’s RatingsDirect talk about leveraged loans. and other public sources. Implied ratings are LIBOR/Euribor floors. A floor under the base not backed by the borrowers. CLO arrang- rate for a loan. For example, if a loan has a ers request the ratings agencies to issue an 3% LIBOR floor and three-month LIBOR falls implied rating to ensure that the portfolio below this level, the base rate for any resets maintains certain agreed standards. For ex- default to 3%. ample, a CLO should not have more than 5% Loan credit default swaps (LCDS). Standard of rated debt in the ‘CCC’ category. derivatives that have secured loans as refer- Institutional facilities. These tranches are ence instruments. sold primarily to institutional investors. They Loss given default. A measure of how much traditionally have had a bullet repayment with creditors lose when an issuer defaults. The no amortization, a maturity of eight to nine loss will vary depending on creditor class and years, and a spread of Euribor + 250 to 325. the enterprise value of the business when it The TLb can have a pricing grid with fewer defaults. Naturally, all things being equal, se- step downs than pro rata. The TLc usually cured creditors will lose less than unsecured does not have a pricing grid. creditors. Likewise, senior creditors will loss Interest coverage. EBITDA to interest. less than subordinated creditors. Calculat- LBO (European version). Any transaction in ing loss given default is tricky business. which the issuer is owned by a private equity Some practitioners express loss as a nominal firm (sponsor). It includes a buyout of a com- percentage of principal or a percentage of pany by a sponsor, a follow-on acquisition, a principal plus accrued interest. Others use a dividend to the sponsor, refinancing, etc. present value calculation using an estimated LBO (U.S. version). A subset of the above, discount rate, typically 15% to 25%, demand- but includes only buyouts of a company by a ed by distressed investors. This can also be sponsor. Excludes recaps, refinancings, and expressed as (1-Recovery Rate). follow-on acquisitions. Maintenance capex. The minimum amount LevX/LCDX. LevX Senior is an index of 40 the company has to spend to keep its assets senior LCDS obligations that participants can in shape. If the company cannot maintain its trade. The U.S. equivalent is LCDX. The indices assets, those assets will not continue gener- provide a straightforward way for participants ating the same level of revenues. to take long or short positions on a broad Mandatory prepayment. Leveraged loans basket of loans as well as to hedge their usually require a borrower to prepay the loans exposure to the market. with proceeds of excess cash flow, asset Leverage ratio or debt/EBITDA. Many bank sales, debt issuance, or equity issuance. books use net debt to EBITDA, which is (debt Mezzanine. A subordinated instrument that minus cash) to EBITDA. carries second-ranking security or, if the Leveraged loans. Defining a leveraged loan is a capital structure also includes second lien, discussion of long standing in the loan market. third-ranking security.

28 Leveraged commentary & data february 2012 www.spcapitaliq.com Glossary

Mulligan. A clause that essentially allows the Pro rata. Facilities sold to banks (revolving borrower a “do-over” on the covenant tests. credit, TLa, acquisition facility, capex facil- If, for example, a sponsor does not comply ity). These tranches generally have a gradual with its covenants for one quarter but is back amortization until maturity (except for the in line the following quarter, the previous revolver) and a maturity of six to seven years. quarter is disregarded as if it never happened. They will usually carry a spread of Euribor + Original issue discount (OID). A way of remu- 200 and greater and might have two to four nerating primary lenders, usually institutional step-downs based on a pricing grid. investors, by offering them a discount to par. Pro rata spread. Average spread of revolving Varies according to demand for the deal. credit and TLa tranches (which are usually Non-call. During the non-call period, bor- the same). rowers are obligated to pay a fee to lenders Public ratings. Ratings that are available pub- if they repay the debt during the stated non- licly on RatingsDirect and other public sources. call period. Generally, the fee is 2% in the first Purchase price multiple. Purchase price paid year and 1% in subsequent years. to acquire the company divided by its EBITDA. OWIC. This stands for “offers wanted in com- Recap/dividend. Capital structure shift in petition” and is effectively a BWIC in reverse. which additional debt is raised to finance Instead of seeking bids, a dealer is asked to a cash payment to the owners (sponsor, in buy a portfolio of paper and solicits potential case of a private company and general pub- sellers for the best offer. lic, in case of a listed company). Some part of P2P (public to private). A buyout of a publicly the new debt may also be used to refinance listed company by a private equity firm result- existing debt. ing in its delisting from the stock exchange. Recap/equity infusion. Capital structure shift in Par amount outstanding. This is the amount which the sponsor injects new equity into the of institutional bank loans issued previously company, usually to refinance existing debt. and still outstanding at the particular point in Recap/stock repurchase. Capital structure time and is tracked by the U.S. and European shift in which additional debt is raised to re- leveraged loan indexes. purchase shares from the owners (sponsor, in Prepayment fee. Fees paid by the issuer if the case of a private company and general public, debt is repaid before maturity. in case of a listed company). Stock repur- Pricing grid (aka margin ratchet). A set of chase can be in the form of shareholder loan financial measures that allows the issuer repayment. Some part of the new debt may to pay lower interest on the facilities. For also be used to refinance existing debt. For example, if the issuer’s debt to EBITDA is less research purposes, dividend and stock repur- than 3x, pricing is Euribor + 275; if such ratio chase are considered the same thing because decreases to 2.5x, pricing is Euribor + 250. both reflect a payment to the sponsor. Primary price (institutional). Reflects how Recapitalization. A shift in the issuer’s capital much investors pay for a facility if they buy it structure between debt and equity. Types of in the primary syndication. Primary price is recap include: dividend, stock repurchase, par unless accompanied by an upfront fee. equity infusion. When the market is strong, institutional paper Recovery. Recovery is the opposite of loss is issued without upfront fees. given default—it is the amount a creditor Printing a deal. Refers to the price or spread recovers, rather than loses, in a given default. at which the deal syndicates. Refinancing. A transaction in which new debt Pro forma financials. Financials that include replaces existing debt of the company and the “side effects” of the current transac- only the debt portion of the capital structure tion. For example, in case of an acquisition, is affected. pro forma EBITDA will reflect the combined Relative value. This can refer to the relative EBITDA of the two companies plus synergies return or spread between (1) various instru- from their merger. For an LBO, pro forma ments of the same issuer, comparing for EBITDA could include cost savings generated instance the loan spread with that of a bond; by headcount reductions. Often pro forma (2) loans or bonds of issuers that are similarly financials covers the last 12 months. We also rated and/or in the same sector, comparing track “estimated” (full fiscal current year) and for instance the loan spread of one ‘BB’ rated “projected year one” (first full year after the healthcare company with that of another; current year). and (3) spreads between markets, comparing

A Guide To The European Loan Market february 2012 29 www.spcapitaliq.com for instance the spread on offer in the loan have maintenance-based financial covenants, market with that of high-yield or corporate usually calculated quarterly, and there is no bonds. Relative value is a way of uncovering equity kicker to debtholders. undervalued, or overvalued, assets. Shareholder loan. Sponsors’ frequently con- Reverse-flex. Spread decrease during syndi- tribute equity in the form of a deeply dis- cation when facilities are oversubscribed to counted bond that pays paid-in-kind interest. the point where a spread reduction will not An equity-like instrument that is subordinat- damage the arranger’s ability to syndicate the ed to senior and subordinated debt. facilities. A sign of demand outstripping supply. Sources of proceeds. Sources used to finance Revolving credit. A facility that allows bor- the transaction (i.e., bank debt, mezzanine, rowers to draw down, repay, and reborrow as high yield, and equity). often as necessary. The facility acts much like Split rating. When a loan is rated differently a corporate credit card, except that borrowers by Moody’s and Standard & Poor’s such that are charged an annual commitment fee on the rating comes out as a “three B” or a “five unused amounts, which drives up the overall B”. “Three B” means ‘B’ (‘B-‘, ‘B’, or ‘B+’) by cost of borrowing (the facility fee). one agency and ‘BB’ (‘BB-‘, ‘BB’, or ‘BB+’) Rich/cheap. A loan that is “rich” is trading by another (if you count all the B’s you’ll get at a spread that is low compared with other three). “Five B” means ‘BB’ by one agency and similarly rated loans in the same sector. ‘BBB’ by another. Conversely, something that is “cheap” means Sponsored (volume, issuance, etc.). Any type it is trading at a spread that is high compared of transaction whereby a private equity group with its peer group. That is, you can buy it owns the issuer. Same thing as the European relatively cheaply. definition of LBO. Rollover equity. Reinvesting funds contributed Spread. Interest paid on top of a “risk-free” to the company under previous ownership rate, i.e., Euribor (for Euro deals) or LIBOR (for into a “new” company under new ownership. U.S. dollar- or sterling-denominated deals). Running the books (or bookrunner). Generally Spread to maturity/spread to call. The spread the loan arranger is said to be “running the to maturity adjusts the value of the spread books,” i.e., preparing documentation and over base rate for any nonpar price, over the syndicating and administering the loan. life of the loan. The spread to call calculates Second lien. Loan that has second-priority the same, except that the time horizon is a interest on security. Subordinated to senior more realistic estimation of the actual life loans (TLa, TLb, TLc, etc.), but senior to mez- of these instruments, which are usually fully zanine, high-yield, PIK notes, and equity. They prepayable without penalty at any time. are floating-rate-instrument-like senior loans, Staple financing. Staple financing—or staple- priced at roughly 200 to 300 bps higher than on financing—is a financing agreement senior loans. Second liens are more expensive “stapled on” to an acquisition, typically by to prepay than senior debt since many second the M&A advisor. So, if a private equity firm is liens have prepayment penalties in the first working with an investment bank to acquire two years. Their maturity is usually one-half to an asset, that bank, or a group of banks, may one year longer than the TLc. provide a staple financing to ensure that the Secondary LBO. A buy-out of a company by firm has the wherewithal to complete the one private equity firm from another private deal. Because the staple financing provides equity firm. guidelines on both structure and leverage, Senior leverage ratio (senior debt to EBITDA). it typically forms the basis for the eventual Many bank books use net senior debt to financing that is negotiated by the auction EBITDA, which is (senior debt minus cash) winner, and the staple provider will usually to EBITDA. serve as one of the arrangers of the financ- Senior loans. These loans have the highest ing, along with the lenders that were backing seniority in the issuer’s capital structure, the buyer. i.e., obligations are contractually paid before Subordinated debt. Debt that has subordi- subordinated securities. They have a stated nated claim on security and payments behind maturity of six to nine years, but are fully pre- senior debt or has no security at all. Types payable at any time and prepayment penal- of subordinated debt are mezzanine, public ties are rare. They are floating rate and priced high yield, and PIK notes (which have certain based on a spread over Euribor or LIBOR. They quasi-equity characteristics).

30 Leveraged commentary & data february 2012 www.spcapitaliq.com Glossary

Term loan. This facility is simply an install- Volume. Sum of all leveraged loans raised ment loan, such as a loan one would use to (first and second lien) within the given buy a car. The borrower may draw on the loan period; new debt raised only. Therefore, if a during a short commitment period and repays deal is an amendment to the previous credit it based on either a scheduled series of re- and no new debt is raised, this will be ex- payments or a one-time lump-sum payment cluded. All amounts are converted to Euros at maturity (bullet payment). using the exchange rate either (1) provided Toggle facilities. This feature provides issuers in the bank book, or (2) spot rate on the with a “pay if you want” feature that allows date of the deal’s bank meeting (our proxy them to switch off any cash-pay element and for a launch date). convert all spread to PIK without consulting Warrants (on mezzanine). Gives the mez- the lending group. zanine lenders the right to purchase equity Total rate of return swaps (TRS). Under a TRS from the issuer at a specific price. War- program, a participant buys the income rants potentially provide unlimited upside stream created by a loan from a counterparty to lenders if the company does really well. on margin. Then the participant receives the However, deals that carry warrants have spread of the loan less the financial cost lower pricing. plus base rate on its collateral account. If Weighted average institutional spread. Average the reference loan defaults, the participant spread of TLb and TLc tranches weighted is obligated to buy it at par or cash settle the by the size of each tranche, i.e. [TLb spread loss based on a mark-to-market price or an times TLb size / (TLb plus TLc size)] + [TLc auction price. spread times TLc size / (TLb plus TLl size)]. Transaction size. Total amount of all debt and Weighted average bid. A price at which an all equity raised for the transaction. investor is willing to buy a loan, weighted by Transferable recapitalization. Buy-out in which the par amount outstanding. By definition, the sponsor has the right to sell the targeted larger deals will have a stronger influence on acquisition to another sponsor without trig- the average. gering a change of control. Yank The Bank. This clause provides for the re- Upfront fee. Fee paid by the arranger to lend- placement of a minority nonconsenting lender ers joining the syndicate, tiered so that larger where the majority of lenders are in agreement. commitments earn larger fees. You Snooze, You Lose. This clause excludes Vendor note (aka seller note). A type of financ- from the final calculation any lender who ing provided by the seller of the company. An fails to reply in a timely fashion to an equity-like instrument that is subordinate to amendment request. senior and subordinated debt.

A Guide To The European Loan Market february 2012 31 www.spcapitaliq.com Boom And Bust Again In 2011

Ruth McGavin he European leveraged credit markets had another exhausting and London (44) 20-7176-3924 Tturbulent year in 2011. The optimists might claim it’s been “two [email protected] steps forward, one step back,” but the pessimists would argue it’s the Marina Lukatsky New York other way around. (1) 212-438-438-2709 marina_lukatsky@ spcapitaliq.com Either way, the year looked something like a making it difficult to get a healthy deal flow microcosm of the 2005-2007 boom to bust: a going in Europe, while the undertow of fairly quiet but optimistic opener in January, distress and restructurings had leading into a rapidly accelerating rally strengthened. The ELLI temporarily crept through the summer that saw the market get back into positive territory, to offer year-to- carried away. Then came a crunch in August date returns of 0.04% by the end of that left arrangers holding long positions in October, but retreated in November, losing loans and high-yield bonds, and a relapse into 0.17% for the year, while the 12-month a shaken, subdued market in the autumn. lagging default rate stood at 3.9%, roughly Reflecting this, year-to-date returns for double the 2% reading from year-end 2010. the S&P European Leveraged Loan Index Of course, the 2007 credit crunch first arose (ELLI) rose 3.85% on the back of the first- from the subprime lending bubble and spread quarter rally, and then rose again to 4.89% outward to infect the U.S. and European in late May. A drop of 6.68% followed, to financial systems, whereas this year it was the negative 2.11% at the start of October. threat of a sovereign default from within the By the end of the year, some liquidity had eurozone. This threat had been hanging over quietly started to rally behind the scenes in the market for many months, but resurfaced Europe, and the U.S. had embarked on a in late summer and continued to build through recovery. But macroeconomic turmoil was the autumn as yields on Greek and Italian

Chart 1 | S&P ELLI: Total Return – Growth of €1,000

()¤ 1,050 1,040 1,030 1,020 1,010 1,000 990 980 970 12/30/2010 2/17/20114/7/2011 5/26/2011 7/14/2011 9/1/2011 10/20/2011 Source: S&P European Leveraged Loan Index. © Standard&Poor’s 2012.

32 Leveraged commentary & data february 2012 www.spcapitaliq.com Boom And Bust Again In 2011

government bonds spiked into dangerous passing 2010’s €42.4 billion. This total has a territory. The notion that a default by Italy or lot more in common with the 2002-2003 era Spain would result in the disintegration of the than the 2006-2007 era when annual loan euro became a real possibility. volume was more than €100 billion higher. Eventually, after many false starts and Out of the 2011 total, €10.2 billion came much political posturing, and after the Greek from non-LBO financing, but sponsor-related and Italian premiers were both forced to transactions still made up the bulk of activity, resign, Europe’s leaders finally seemed to at €33.2 billion. realize the severity of the situation, ahead of Dividing the year’s volume into before and a summit in early December. But as the year after the resurgence of sovereign risk per- drew to a close, it was by no means clear that ception tells the story of the year. Between they had done enough to persuade the January and the end of July, total senior loan international markets of the region’s stability. issuance amounted to €33.65 billion, com- Even assuming that Sarkozy, Merkel, et al, pared with just €9.64 billion from the begin- do manage to talk the euro down off the ning of August to November. ledge, the region is set for an extended The pace of issuance picked up quickly in period of low or no growth, varying from the first half, aided by a string of large country to country. GDP will grow by just 0.5% repayments that put cash back into the in the eurozone in 2012, according to the hands of CLO managers. European Commission’s autumn forecast. Sponsors quickly moved to seek more With this in the background, and the wall of aggressive terms, and arrangers’ desire for leveraged loan maturities in the foreground, mandates saw bidding get highly competitive, there should be interesting opportunities for giving back some of the ground on stressed and distressed players, but primary documentation that had been won in the opportunities may be slender. leaner years. Leverage rose, spreads The eurozone crisis drained the leveraged compressed, and deal sizes increased. debt market of the crucial ingredient—confi- Among the larger deals were Gruppo Coin’s dence—that allows deals to get done. Banks €985 million all-senior debt package and the were shy to take underwriting risk and get- €1.34 billion secondary LBO loan for Spie. ting stuck with another deal—whether bond RAC, Versatel, Coin, and others opted for all- or loan—that would prove prohibitively senior debt packages with large TLb portions, expensive to sell down into the volatile mar- so sure were the underwriters in the strength kets. A handful of auctions pushed ahead but of the bid. the expectation was for a tepid start to 2012 However, this bubble of confidence burst in terms of primary transactions. on contact with sovereign debt worries, and arrangers found themselves left holding long positions, in an unhappy reminder of the Volume: Loans Versus Bonds second half of 2007. Hung deals included Senior loan volume for 2011 through RAC, Versatel, Spie, Oberthur, Jack Wolfskin, November amounted to €43.3 billion, just Bureau Van Dijk, Com Hem, Action, and

Chart 2 | European Leveraged Finance New-Issue Volume

Leveraged loans Mezzanine High-yield bonds (Bil. ¤) 250

200

150

100

50

0 2006 2007 2008 2009 2010 Jan–Nov 2011 Source: S&P Capital IQ LCD. © Standard & Poor’s 2012.

A Guide To The European Loan Market february 2012 33 www.spcapitaliq.com Mondo. Unsold bond bridges included Coditel, The volatile times mean arrangers need to Polkomtel, and Ascometal. Arrangers set to be able to access any and all pools of capital work trying to find clearing prices, and to clear the books at the best price. managed to get down to comfortable holds Arrangers that have neither a high-yield of many of these—but at a cost. franchise nor the ability to do large take- Some banks had to use all their fees and and-hold positions will start to find more to find buyers, as well as exploring themselves squeezed out of the larger deals, options for switching senior to mezzanine, sources say. loans to bonds, or vice versa. Where deals remained unsold as year-end approached, arrangers were left to pray that the credits in It’s A Technical Market question would manage to sustain a decent Over the past few years, Europe has become performance in the face of an economic an increasingly technical market, and this slowdown across Europe. was particularly evident in 2011. On the high-yield side bond side, 2011 has During the years when banks and CLOs been nothing very remarkable in terms of were the main investor groups, Europe simply volume, at €35.3 billion (split almost equally operated as a par market for primary between secured and unsecured) through issuance. Demand outweighed supply, paper Nov. 30, compared with €44.4 billion in 2010. consistently traded at par or above in the Issuance was brisk in the first half, but secondary market, and there was little or no inevitably the window closed in late summer, thought given to comps when it came to with only a scattering of companies pricing new debt. accessing the market in the autumn. Now, things have changed. To access the But putting aside absolute volume, high- maximum amount of liquidity, arrangers have yield has further embedded itself in the to offer paper that is competitive with yields European leveraged debt psyche this year. offered in secondary. They might have to Sponsors relied heavily on it to refinance consider the yield on the borrower’s aging deals: 27% of the year’s issuance refi- outstanding debt, or on a comparable loan or nanced bank debt and another 40% refi- bond, or the yield on offer in the U.S. market. nanced other debt. But it was also fruitful for The path of the secondary bid during 2011 new credits, with 21% of the total used for illustrates just how flexible they had to be. mergers and acquisition. The average bid of LCD’s flow names (based Unlike in 2006/2007, when high-yield was on pricing from Markit), rose from 97.87 at very much a sideshow to the might of the the start of January and hovered just below loan market, now it is on a more even footing, par in March, April, and May. June and July particularly for larger deals. Secured issuance saw the bid soften back to the low 97s as made up less than one-half of the January- sovereign debt clouds built up. November total, at €16.2 billion versus €19.1 In early August the average bid dived to billion unsecured, but senior secured will 93.46. This was followed by volatility and a continue to be a useful tool for new deals, as lack of clear direction through the autumn, well as for refinancing. as it bounced around in the 91-94 territory.

Chart 3 | LCD’s European Flow Names: Avg. Bid vs. Avg. Ask

Avg. bid Avg. ask 102 98 94 90 86 82 78 74 70 66 62 58 1/5/2008 6/11/2008 14/05/09 19/11/09 27/05/10 2/12/2010 9/6/2011 15/12/11 Sources: MarkltLoans; S&P Capital IQ LCD. © Standard & Poor’s 2012.

34 Leveraged commentary & data february 2012 www.spcapitaliq.com Boom And Bust Again In 2011

At the start of December, it was Some firms have established large global down at 93.72. vehicles and there is further U.S. interest in The key driver behind this shift is the Europe in the wings, while managed account change in the CLOs market, and in the money has flowed in—and out—of the market constituents of the overall investor base. but with little transparency on quantum. CLOs remain a powerful buying force in Managers would love to see low-levered CLO Europe, but only when they have received vehicles emerge, but so far there has been no cash from repayments. So demand ebbs and sign of success in Europe. flows, and there is no longer a constant Another format for fundraising is the listed hunger from these vehicles as there once fund, which has the potential to bring in cash was. Their appetite relies in part on that would otherwise be barred by the fact refinancings via high-yield, so the two that the product is not Undertaking for markets are more closely correlated, albeit Collective Investment in Transferable with something of a lag. Securities-friendly. Numerous managers are During 2011, repayments have been in the early stages of exploring this option. strong. The first three quarters of the year So far, Neuberger Berman and HarbourVest saw a total of €31.1 billion repaid out of the are among the handful that have raised listed ELLI. This is the same amount that was funds, and several others (Babson and repaid in the first three quarters of 2007, but Alcentra included) are set to go down this no other previous year even comes close. May route when conditions allow. 2011 was a stand-out month, with a record The fundraising road was tough in 2011, €8.3 billion repaid. thanks to the high-risk-perception of But the lack of high-yield activity in the Europe, and managers know they will have autumn led to an easing in the rate of to work very hard for every euro (or, if the repayments. Not only did CLOs have less pessimists prevail, every deutschmark) next cash, but managers also saw good buying year. Sources say they are well aware that opportunities in the soft secondary market. European loans will only draw liquidity if the LCD’s flow names offered a discounted yields make sense against other spread to maturity of Euribor (E)+600-650 opportunities. Even if money does start to through the autumn, roughly 200 bps higher flow into the product, there is no likelihood than in the first half of the year, and to tempt that the amount of CLO capacity that funds in, primary deals had to offer a Europe is set to lose in the next 12 to 24 comparable yield. months will be anywhere near matched by Many non-CLO funds are even more incoming cash. focused on relative value, since many of them High-yield fundraising has seen new can choose freely between high-yield and entrants such as T.Rowe and SYZ & CO, while loans, Europe and U.S., senior and Cazenove and AXA Investment Management subordinated. CLOs took a 63.8% share of the are among those preparing to launch new institutional investor base in the 12 months funds. Much of the new money will have a to the end of September, which is larger than global focus, however, rather than being the full-year 2010 share of 54.6%. Credit dedicated to Europe. Over the year, flows into funds and separately managed accounts took existing funds, as tracked by J.P. Morgan, 26.1% in the year through September, down were poised at a net inflow of €522 million at from 32.7% in 2010. the end of November, despite some hefty However, over the next two years, CLOs’ outflows after the summer crunch. buying power will start to diminish as more and more vehicles exit their reinvestment periods. This will transform a huge chunk of Record-High Spreads the European investor base onto a quasi- In the first half of the year, it was not difficult static footing, gradually winding down for arrangers to match secondary value as rather than actively playing in new deals the average bid was so close to par and a and refinancings. slew of repayments meant there was plenty As the traditional, highly-levered CLOs of demand. But after the crunch, when freeze up, other forms of institutional money arrangers were trying to shift long positions, are set to take a growing share, such as it became much more expensive to compete managed accounts and global credit funds. with secondary. Having used all their flex on

A Guide To The European Loan Market february 2012 35 www.spcapitaliq.com the margin, arrangers (especially those with As a result, the average new-issue TLb hung deals) had to push offer prices down to yield rose to a record high in the three lows rarely seen before in Europe. months to the end of October, at 7.68% and As a result, the average yield to maturity climbed again in November to 7.73%. rose to record highs during the autumn. At this level, it seems to compare favorably The average TLb/TLc spread momentarily with the U.S., which fell from 7.99% in topped E+500 in August 2010 (on a rolling September to 7.05% in November. But the three-month basis) but then fell month by first quarter deal flow for Europe looks thin, month to a low of E+432.8 in May 2011. From so there may be little in primary to actually there it rose back toward E+500, reaching test and confirm the depth of investor E+505 in November. appetite at this level. But this only part of the story. Arrangers Instead, arrangers and sponsors may prefer had to offer large original issue discounts in to push paper over to the U.S. if they have the the autumn to shift paper. The average issue option, where debt is cheaper, and the market price fell away over the course of the year, is more liquid and transparent, leaving Europe from 99.77 in the first quarter, to 95.68 in the high and dry. Finding a price point that draws three months to the end of November, liquidity into Europe but that is palatable for boosting the yield to maturity. sponsors will be a difficult balancing act.

Chart 4 | Average Term Loan B Primary Spread And Yield To Maturity*

Rolling three months

Avg. term loanBspread Avg. yield to maturityfor term loan B (Basis points) 800 750 700 650 600 550 500 450 400

1

1

1

1

1

1

11

11

2011

2011

2011

2011

2010

2010

2009

2010

2010

2010

2010

. 20

. 20

July

July

May 1 May 1

. 2010

.

april

April

June June

v.

v.

March 1

March 1

Oct.

b. Fe

Jan

Oct.

No

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b. Fe

Jan

No

Dec.

Dec.

Aug

Sept.

Sept. *Based on the term loanBspread at launch, the OID, and EURIBOR floor (if any). Source: S&P Capital IQ LCD. ©Standard & Poor’s 2012.

Chart 5 | Annual Pro Forma Debt/EBITDA Ratios*

First-lien/EBITDA Second-lien/EBITDA Other debt/EBITDA (x) 7 6 5 4 3 2 1 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Jan.– Nov. 2011 *Excludes broadcasting, cable and telecom loans prior to 2002. Source: S&P Capital IQ LCD. © Standard & Poor’s 2012.

36 Leveraged commentary & data february 2012 www.spcapitaliq.com Boom And Bust Again In 2011

The high-yield market saw spreads rise Shrinking, Or Rightsizing? over the course of the year. ‘B’ rated names As well as a shift toward a more technical rose from 8.4% in the first quarter, to 8.6% in marketplace, Europe is also moving toward the second, and to 9.1% in the third—but this being a smaller market. This shrinking can is still some way off the highs of 2009, when also be depicted as a “rightsizing”—finding a the average primary yield was 12.4% in the size that can be sustained without the first half of the year. ‘BB’s tracked from 6.8% bloating effect of 10x levered CLO money. in the first quarter to 7.7% in the three Looking ahead, sources agree that months to end-November. austerity is coming to the loan market: When it comes to pricing new transactions smaller deals, with smaller syndicates, in 2012, fund managers are all too aware arranged by smaller teams, earning smaller that the persistent volatility in Europe means remuneration, from a smaller number of that even the best asset—whether loan or banks. Eventually a sustainable size will bond—is almost certain to trade off at some emerge, without the inflation provided by point. This makes life even more difficult for CLO leverage. arrangers. “Don’t put more than 50% of your “History will show that ’06 and ’07 were an fire power into any deal,” says one fund anomaly, not the norm,” a fund manager says. manager, on the grounds that you will The total par amount tracked by the ELLI invariably get a chance to buy it cheaper has shrunk, to the extent that the Index has within a few months. lost nearly one-quarter of its peak volume. In As evidence, various credits launched October 2008, there were €148 billion of during 2011 did trade off heavily, some hit loans in the Index, but by Dec. 1, 2011, the by country risk aversion and others by total size was 24% lower at €113 billion. disappointing trading. These included The U.S. market, as per the S&P/LSTA bonds for the likes of Kion, Cirsa, and Leveraged Loan Index (LLI), has also shrunk Ontex, which dropped 20 points of more from its €462.1 billion (equivalent) peak in from reoffer. 2008 to €383.7 billion by November 2011. However, along the way it has also enjoyed Leverage Down growth spurts: for example, it grew pretty consistently from April to September. While spreads are at these record high levels, The ELLI, on the other hand, has continued it is worth noting what has happened to to decline almost every month since its peak. leverage multiples in 2011. The rate of shrinkage in Europe was slow and For the year as a whole, leverage is up very steady through 2009 and 2010, but slightly (4.38x for 2011 through end- accelerated in 2011. November, versus 4.24x for 2010), and equity The decline has been fuelled by several contributions to LBOs are down (to 44.1% sources. On the exit side: trade buyers picked from 46.9% last year). off leveraged assets, and sponsors refinanced Since LCD’s began tracking the data, aging loans via the high-yield bond market. European total debt to EBITDA has On the entrant side: new issue volume was consistently been higher than in the U.S., and slim thanks to a lack of supply of new assets, this continued to be true in 2011. But the gap since corporates were reluctant to sell while between the two markets is minuscule— financing conditions were so tough. 4.42x for Europe versus 4.39x for the U.S., Indeed, over the last 12 quarters—right which undermined Europe’s entrenched back to the fourth quarter of 2008—there reputation for being a higher-levered market has only been one quarter in which new than the U.S. Looking at senior debt only, the issuance of institutional paper outstripped U.S. was at 4.1x versus 4.06x for Europe repayments from the ELLI. During that time, (through September). €65.3 billion exited the ELLI, and only €38.3 If this is sustained into next year, billion of new institutional paper was offered. comparable—or even lower—leverage and Conversely, before fourth-quarter 2008, LCD higher spreads might help to draw more did not record a single quarter in which opportunistic money toward Europe. “We’ll repayments were greater than new issuance, start with opportunistic liquidity, and and at its height in second-quarter 2007 new gradually we’ll get a more stable flow of issuance outweighed repayments by more funds,” says an investor. than €35 billion.

A Guide To The European Loan Market february 2012 37 www.spcapitaliq.com Chart 6 | Institutional Leveraged Loan Maturity Wall

Besed on S&P European Leveraged Loan Index

Year-end 2010 As of Dec. 1, 2011

(Bil. ¤) 50 45 40 35 30 25 20 15 10 5 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Sources: S&P Capital IQ LCD; S&P European Leveraged Loan Index. © Standard & Poor’s 2012.

All of this means that the total par is now down to €328 million for 2011 to the outstanding in the ELLI is at its lowest since end of November. By comparison, the February 2007, and the forces at work in the average was somewhere roughly around the leveraged financing markets suggest that the €400 million mark in 2002-2004. shrinking is going to continue. Furthermore, year to date, deals with senior For a start, the maturity wall needs further debt over €1 billion have made up less than work: there is still €10.3 billion of paper in 2% of new LBO issuance, down from more the ELLI set to mature by the end of 2013, than 14% in 2007. and €30 billion by the end of 2014. It is But while the loan market is shrinking, the impossible to see how the loan market could European high-yield market has been reabsorb all the credits that need to be booming, bringing opportunities to banks and refinanced. The ebbing CLO bid as asset managers that have positioned reinvestment periods end will play a key part themselves to play in either market. Private in forcing borrowers to look elsewhere. equity sponsors had already started to make The strength of nonleveraged corporate more use of the European high-yield bond balance sheets will also play a part in market for new buyouts as well as to shrinking the market, over the near term. refinance aging loans, and this is set to Cash-rich and opportunistic, these continue into the coming year, as they will companies will be more interested in buying want all the firepower and all the options sponsor-owned businesses than selling available to them. divisions into private equity hands, and will At the end of 2008, the par amount also be formidable auction adversaries, tracked by the ELLI totaled €142.8 billion, according to market sources. “Investment- about twice the amount outstanding in the grade corporates are in good shape. They are Bank of America Merrill Lynch European High- not forced sellers,” a source notes. Yield Bond Index (MLHY), at €70.2 billion. The average debt size for leveraged loans However, by Nov. 24, 2011, the ELLI had and LBOs has been shrinking since the shrunk to €114 billion, while the MLHY more 2006-2007 era. From €566 million in 2007 it than doubled, to €147.9 billion. l

38 Leveraged commentary & data february 2012 www.spcapitaliq.com Eurozone Risks Will Weigh On Corporates If They Can’t Find Growth Globally

Primary Credit Analyst: ountry risks, rather than cyclical swings, will determine the credit Paul Watters London Cfortunes of European corporates over the coming year, in Standard & (44) 20-7176-3542 paul_watters@ Poor’s Ratings Services’ view. As sovereigns in the European Economic and standardandpoors.com Monetary Union (EMU or eurozone) struggle to reduce debt while Secondary Contacts: Guy Deslondes supporting growth, we anticipate that companies with localized operations Milan (39) 02-72111-213 in countries hardest hit by weak consumer demand and austerity measures guy_deslondes@ will be most exposed to some degree of downgrades. By contrast, standardandpoors.com

Blaise Ganguin corporates that trade goods and services globally should in our opinion be Paris better insulated from the turbulence engulfing the eurozone, irrespective of (33) 1-4420-6698 blaise_ganguin@ industry-specific cycles that usually prevail over credit developments. We standardandpoors.com think these companies will be able to rely on continued relatively strong Tobias Mock Frankfurt growth in emerging markets and other commodity-producing countries (49) 69-33-999-126 tobias_mock@ that are providing most of the momentum for global growth. standardandpoors.com

Peter Tuving Stockholm Overview (46) 8-440-5913 •• European corporates with localized operations in regions hardest hit by the eurozone peter_tuving@ crisis will be most exposed to rating downgrades over the coming months, in our view. standardandpoors.com •• Companies that sell goods and services globally, especially in strongly growing emerging Chief Economist, Europe: countries, will be better insulated. Jean-Michel Six •• Rated corporates, particularly investment-grade firms, are better prepared for a renewed Paris (33)-1-44-20-67-05 downturn than in 2008, owing to tight working capital, conservative financial policies, and jean-michel_six@ higher cash balances. standardandpoors.com •• Regulatory pressures and the cost of bank funding will continue to constrain bank lending. • Additional Contact: • Highly leveraged corporates, particularly legacy LBOs needing to refinance over the next Industrial Ratings Europe two years, could face refinancing difficulties. CorporateFinanceEurope@ •• We expect a mild recession in Europe and still solid growth in emerging markets. standardandpoors.com

In spite of tremendous economic uncer- companies have taken advantage of tainties, the majority of corporates we rate improved financial market conditions prior are entering 2012 with stable outlooks. to July 2011 to strengthen their liquidity Only 18.8% currently have a negative out- and reduce their leverage. This should help look or are on CreditWatch negative, a sig- them weather with only limited credit dete- nificant drop from 37.0% at the end of rioration the short-lived recession in 2009. We believe this is because many Europe that Standard & Poor’s economists

A Guide To The European Loan Market february 2012 39 www.spcapitaliq.com expect in the first half of 2012 (see further details see “European Corporate “European Economic Outlook: Back In Defaults Likely To Rise In 2012 On Gloomy Recession,” published Dec. 1, 2011, on Business And Financing Prospects” published RatingsDirect on the Global Credit Portal). on Jan. 18, 2012 on RatingsDirect). We therefore expect that investment- grade corporates will be able to retain steady access to debt capital markets in the Downgrades Could Loom For Companies year ahead. Yet, volatile financial markets With Localized Operations and competing demands for wholesale The eurozone sovereign crisis will in our funding from governments and banks will view weigh on the credit prospects of create execution challenges and translate European corporates over the coming into higher risk premiums overall. Not least, months. This could potentially lead to some we believe it will be difficult to establish degree of negative rating actions for com- appropriate market clearing prices for panies with significant exposure to GIIPS investment-grade primary deals relative to economies (Greece, Italy, Ireland, Portugal, more expensive transactions from European and Spain), which are hardest hit by the sovereigns and financial institutions. sovereign debt crisis. Progress in resolving Furthermore, we think banks will continue to the eurozone’s financial problems will likely refocus on their core domestic business and be drawn out. The policy response of fiscal shrink their balance sheets to meet the target tightening and supply-side reforms will 9% core tier 1 capital ratios by end-June 2012, inevitably take time, with no guarantee of as stipulated by the European Banking Authority success. Business and consumer confi- (EBA). Ongoing regulatory changes relating to dence is likely to continue to suffer, in our Basel III and Solvency II will also likely continue view, at least through early 2012. We also to shift the provision of corporate term funding consider it highly likely that the weakness in away from banks toward the bond market. High the so-called “peripheral” economies will short-term funding costs for banks can only increasingly spread to the core of Europe. accelerate this move away from bank Under our latest base-case economic fore- intermediation, in our view. cast, eurozone growth as a whole will slide While we anticipate the high-yield bond to 0.4% in 2012, with Germany acting as market will continue its long-term growth in locomotive at 0.6%. Standard & Poor’s 2012, we think investor appetite is likely to economists currently forecast a mild reces- be less voracious than in recent years amid sion for the eurozone in the first half of the prevailing economic uncertainty. We believe year, and see a 40% chance of a deeper issuers will have to be well prepared to recession materializing. capitalize on issuing windows when they We therefore believe that Europe is arise. Those with U.S. dollar revenue entering an atypical period in which streams will likely capitalize on stronger downward rating pressure will be derived market conditions to raise financing in the from two key sources: government spending U.S. Weaker ‘B’ rated companies, and even cutbacks and the knock-on impact of those in the ‘BB’ category that additionally austerity measures on local consumers and face high country exposure and have to businesses. We think utilities and complete refinancing ahead of 2012/2013, incumbent telecoms, which by definition are could face particular difficulties this year, highly local, could be hardest hit, given that in our view. they provide essential services in their host In this context, and given the prospect of countries. Yet, we also predict some €69 billion of speculative-grade debt (that transportation segments, such as regional is, rated ‘bb+’ or below) maturing in 2012- airports Aeroporti di Roma SpA 2013, we anticipate that defaults could (BB/Negative/B), and Copenhagen Airports increase to 6.1% by the end of December A/S (BBB-/Negative/—), could feel the 2012. This is up from 4.8% at the end of effects of consumer retrenchment, not 2011, combining publicly rated and private helped by higher passenger duties. credit estimate defaults in Europe. European steel producers and oil refiners Nevertheless, we expect corporate defaults that are exposed to declining profitability, will stay significantly below the 14.7% peak could also feel the effects of harsher times recorded in the third quarter of 2009 (for because lower demand and capacity

40 Leveraged commentary & data february 2012 www.spcapitaliq.com Eurozone Risks Will Weigh On Corporates If They Can’t Find Growth Globally

utilization are creating downward price than at a similar point in the cycle in January pressures, while traded commodity input 2008 (see chart 1). costs remain high on China demand. Should budget deficits in countries with By contrast, we think that companies that austerity programs deteriorate further, we trade goods and services globally should be believe governments may resort to windfall better insulated from the eurozone taxes on corporate profits or other state turbulence, even in highly cyclical sectors. intervention, such as selling minority They should be able to rely on continued government stakes in companies, which relatively strong growth in the developing could also dent credit quality. Highly rated world and other commodity-producing government-related entities (GREs) could countries. Since the last downturn of see negative rating actions if host sovereign 2008/2009, for example, we think European ratings were lowered, according to our auto manufacturers have become more criteria. Yet ratings may also be affected if global players. They have taken strides to we were to reassess our view on the likely improve their operational efficiency, extent of extraordinary state support. This strengthen their balance sheets, and arose, for example, in the case of power diversify their sales and operations outside grid operator REN-Redes Energeticas Western Europe. Nonetheless, we see Nacionais SGPS S.A. (BBB-/Watch Neg/A-3) the luxury rated car makers BMW AG and rail infrastructure manager Rede (A-/Positive/A-2) and Daimler AG Ferroviaria Nacional REFER E.P.E. (BBB+/Positive/A-2) as better placed, in (B-/Watch Neg/—) in Portugal last March view of the brand consciousness of the 2011, when we revised our opinion on the aspiring middle classes in developing ability of the Portuguese government to markets, than the volume producers Peugeot provide timely support, if required, because S.A., Renault S.A. (both BB+/Stable/B), and of growing demands placed on the Fiat SpA (BB/Negative/B), which still have a government’s limited resource base. higher percentage of unit sales in Europe. Austerity programs and rising Mirroring our expectation of diverging unemployment in the GIIPS will also keep fortunes between locally and globally consumer demand under considerable operating companies 2012, we currently pressure, in our opinion. This is likely to be have a relatively higher proportion of to the detriment of the performance and negative outlooks or CreditWatch negative credit quality of those companies most placements in utilities, telecoms, steel, oil exposed to these regions. We project that and gas, and some transportation segments locally operating clothes and shoe retailers

Chart 1 | More Negative Outlooks For Corporates With Localized Operations

Defensive sectors Cyclical sectors

(Jan. 2008 negative outlooks/CreditWatch Neg (% of sector) (%)

50

40 Forest Building Transport products materials 30 Packaging TechnologyTechnology Consumer products Telecom Utilities 20 Media & entertainment Auto & Chemicals components Hotels & gaming Capital goods Real Metals & mining Health care 10 Retail estate Energy 0 01020304050 Jan. 2012 negative outlook/CreditWatch Neg (% of sector) © Standard&Poor’s 2012.

A Guide To The European Loan Market february 2012 41 www.spcapitaliq.com in the mid to low market segments, as well in our estimation. This is either because as consumer electronics, and even food their FFO has improved—such as in retailers are likely to struggle. Carrefour S.A. chemicals and capital goods—or because (BBB+/Negative/A-2) and Tesco PLC dividends are substantial—such as in (A-/Stable/A-2), the second- and third- telcos, oil and gas, health care, utilities, largest food retailers in the world, are both and consumer products. currently experiencing margin pressures, owing to significant exposure to their core markets of Western Europe and the U.K., Tighter Bank Lending May Curb respectively. Nevertheless, their emerging Borrowing And Add To Defaults market activities and Internet sales could Further adding to corporate credit pressures, provide some support. The prospect of lower we expect the lending relationship between inflation on the back of falling commodity banks and corporates to remain in flux over and energy prices should also help alleviate the coming year. In the near term, the margin pressure and provide some limited European Banking Authority-mandated rush respite for consumers’ real disposable for banks to increase Tier 1 core equity to incomes. By contrast, we believe the 9% by June 2012 will in our view dampen performance of global branded consumer new money corporate lending as most goods companies will be supported by the affected banks seek to reduce risk-weighted super rich and the aspirant middle class in assets, including through the sale of non- the BRIC countries (Brazil, Russia, India, and core assets. In the longer run, we think that China) and will continue to outperform the as banks’ business models adapt to a lower broader consumer goods sector in the leveraged and more capital-intensive coming years. Companies such as regulatory environment, they will likely LVMH Moet Hennessy Louis Vuitton S.A. further ration corporate credit. For further (LVMH; A/Stable/A-1) and PPR S.A. details see ”Why Basel III And Solvency II Will (BBB-/Positive/A-3) should be well placed to Hurt Corporate Borrowing In Europe More capitalize on this trend (for further details Than In The U.S.” published Sept. 27, 2011, see “Can Luxury Goods Continue To Deliver on RatingsDirect. This would favor shorter Rich Returns In An Era Of Austerity?” term and unfunded facilities, albeit on more published on Nov. 14, 2011, on RatingsDirect). expensive terms. We anticipate that the Another drag on corporate ratings, in our requirement for ancillary business will over view, is that certain sectors have exhausted time reduce the size of syndicate groups. their flexibility to defer growth capital In this volatile funding environment, we investments as a means of preserving cash think it will be paramount that corporates amid the uncertain economic outlook. maintain at least adequate liquidity. We Having cut back on capital expenditure in anticipate that they will extend committed recent years, we think that firms in retail, facilities beyond 12 months and wherever leisure, and building materials now have possible seek to refinance bank debt at least little option but to invest to protect their 15-18 months in advance of maturity. This longer term competitive positions. We will be more palatable for banks’ loan expect high-grade telecom companies, for exposures in the speculative grade arena, example, to further increase capital where the principle outstanding can be investments to acquire 4G licenses and reduced through a repayment or refinanced build out the necessary infrastructure. in whole or in part via the bond market. Similarly, while corporates’ generally However, we believe that smaller companies prudent financial policies over recent years and vulnerable LBOs—rated and unrated— should continue to underpin credit quality with highly leveraged credit profiles will through 2012, this support could be eroded struggle to access external debt funding on if a deeper recession materializes. Capital terms they can afford. This includes many expenditures, dividends, and share smaller firms operating in the supply chain, buybacks are already low in sectors such as which are already under severe pressure from steel and building materials, where funds retailers and manufacturers to absorb higher from operations (FFO) have not improved costs. They could also experience a renewed since 2007. Some sectors still have some credit crunch as debt financing becomes discretion to cut back to improve liquidity, more restrictive.

42 Leveraged commentary & data february 2012 www.spcapitaliq.com Eurozone Risks Will Weigh On Corporates If They Can’t Find Growth Globally

Weaker LBOs are also vulnerable to a less Defensive Financial Policies forgiving approach from senior bank Provide A Credit Buffer lenders, in our view. Their recent policy to In spite of these adverse conditions, we offer temporary relief through loan anticipate any deterioration in credit quality of amendments and extensions for borrowers our European rated corporates would be in distress is reaching its limits in the generally limited to a rating outlook change or current climate. The ongoing focus on a one-notch downgrade. One reason for this recapitalizing the European banking system is that many companies appear to have and the tighter regulatory capital regime capitalized on the stronger than expected will, sooner or later, require a more recovery over the past two years to improve conservative and transparent accounting their financial performance by implementing treatment of legacy assets, essential for efficiency programs, prioritizing free restoring credibility to European banks’ operating cash flow, strengthening balance balance sheets. This is likely to usher in a sheets, and improving liquidity. This has led to new round of restructurings for LBOs that some rating upgrades (see chart 2), or we view as unsustainably leveraged (at provided good headroom for their credit ratios above 6x debt to EBITDA) ahead of the final at current rating levels. For instance, strongly 2013-2014 debt maturity date of many improved operating performance and/or a 2006-2008 vintage LBOs. supportive financial policy resulted in In this context, we expect the rate of upgrades for a number of chemical defaults could increase among highly companies early in 2011, inclu ding leveraged companies. We forecast that the Evonik Industries (BBB/Stable/A-2), speculative-grade default rate will rise to 6.1% Rhodia (BBB+/Negative/A-2), SPCM S.A. by the end of December 2012, from 4.8% at (BB/Stable/—), and Ineos Group Holdings the end of December 2011. This is based on S.A. (B-/Stable/—), as well as for capital our pool of corporates in the EU27 countries goods companies such as Sandvik AB (plus Iceland, Norway, and Switzerland) that (BBB+/Stable/A-2) and Assa Abloy AB either have public ratings or for which we have (A-/Negative/A-2). provided private credit estimates. We see an Most rated companies have also taken upside risk of defaults rising to 8.4% by the advantage of improved financial market end of this year. This is a modest upward conditions prior to July 2011 to refinance revision to our previous forecast of 5.5%-7.5% debt due over the coming few years, for 2012/13 made at the end of 2010. (For strengthening their liquidity position in the further details see “European Corporate process. We calculate, for example, that Defaults Likely To Rise In 2012 On Gloomy our rated European corporates prudently Business And Financing Prospects” published increased their cash balances, including Jan. 18, 2012, on RatingsDirect). short-term investments, by 33% between

Chart 2 | EMEA Corporate Rating Changes Versus Outlook Bias 2011

Positive-negative outlooks/total in sector (%) 30 Downgrade 2011/ Upgrade 2011/ positive outlook 2012 Forest products positive outlook 2012 20 Packaging Auto & components 10 Capital goods Health care Consumer products Aero & defense Real 0 estate Technology Retail Chemicals (10) Media & ent. Energy Business services Metals & (20) Utilitiess mining Building materials Hotels & gaming (30) Telecom Downgrade 2011/ Transport Upgrade 2011/ negative outlook 2012 negative outlook 2012 (40) (40) (30) (20) (10) 0410 20 30 0

Upgrades-downgrades/total in sector (%)

Bubble size equals relative number of 2011 upgrades. © Standard&Poor’s 2012.

A Guide To The European Loan Market february 2012 43 www.spcapitaliq.com 2007 and the end of 2010 to a total €680 the euro area falling below 2% in the billion at the end of 2010. This provides coming months, according to our substantial flexibility, not least for sectors economists, could give the European such as oil and gas, utilities, and mining, Central Bank (AAA/Stable/A-1+) some which have substantial capital expenditure flexibility to ease monetary policy f urther. needs for expansion that they are unlikely Together with the likely further weakness to fund completely out of operating cash in the euro, this should improve the flows. The uncertain economic outlook, lack competitiveness of European exporters. of available debt financing, and relatively Finally, we also anticipate that monetary high valuations, have also put the brakes policy will stay unconventional and highly on spending on mergers and acquisitions. stimulative in Europe and the U.K. until We envisage some pick-up, however, if 2013, which should at least mitigate opportunities arise to make midsize ongoing fiscal consolidation efforts and strategic acquisitions at an attractive price. boost credit support for corporates. The What’s more, hoarding cash, while prudent shape of sovereign yield curves will continue for companies individually, is likely to to be a strong signal attesting to the reinforce the downturn if applied credibility of budget stabilization programs collectively, and we can envisage that in austerity countries, in our view. companies will increasingly be pressured to deploy the excess cash balances that they have accumulated over the course of 2012. Predominantly Stable Outlooks Further underpinning the credit strength Mirror Rated Corporates’ Strong of exporting companies, we expect Global Presence demand from developing and emerging Given our base-case forecast for anemic markets in general to stay strong in 2012. growth in the eurozone and the U.K. through In China, for instance, our economists 2012, it may seem incongruous that the rating anticipate growth remaining high at about outlook bias for companies across all sectors 8% in 2012. This is slower than over 2010- is more stable than it has been for several 2011 (about 9.5%) but more sustainable, years. The proportion of negative outlooks on in our view (for further details see rated companies does not exceed 30% in any “People’s Republic of China,” published sector (see chart 3). We see a number of Dec. 23, 2011, on RatingsDirect). We also reasons for this, all of which bode well for rated anticipate that the prospect of inflation in companies’ credit prospects. First, it illustrates

Chart 3 | EMEA Corporates Outlook/CreditWatch Distribution*

Outlook/CreditWatch Negative Outlook/CreditWatch Stable Outlook/CreditWatch Developing Outlook/CreditWatch Positive

(%) 100

80

60

40

20

0

s

s

s

e

care

ense

ining

erials

Retail

goods

vicess

estat

Energy

elecom

gaming

Utilities

roduct

def

ponent

T

product

ser

mat

&

ansport Tr

echnology

Packaging

t

Chemicals

s & m

s

ertainment

Real

g

T

Health

o &

com

Capital

ent

Aer

res Fo

Metal

o &

Hotels

Buildin

a &

Busines

Consumer p

Aut

Medi

*As of Jan. 9, 2012. © Standard&Poor’s 2012.

44 Leveraged commentary & data february 2012 www.spcapitaliq.com Eurozone Risks Will Weigh On Corporates If They Can’t Find Growth Globally

the prudent financial policies companies have impact on the ratings outlook for our adopted over the past two to three years to European cyclical sectors. The continued defend themselves against more adverse strength of these markets underpins our economic conditions, such as implementing assumption of relative stability for cyclical efficiency programs, prioritizing free operating global sectors, such as autos, chemicals, oil cash flow, strengthening balance sheets, and and gas, metals and mining, and capital improving liquidity. Second, it reflects the goods. Neither our base-case nor our strong export orientation of many rated downside scenarios for the coming months companies. Lastly, we note that our rated pool factor in any significant weakening in of companies is biased toward multinational emerging market demand. This is, corporates with a strong operational presence nonetheless, one of the low-probability but in global markets, including stronger growing high-impact tail risks that we keep under BRIC and other emerging markets. We believe review. Others include a disorderly breakup of this makes them more resilient against the EMU or an unexpected acceleration of weakness in their home markets than the inflation induced by either excessive European corporate credit sector as a whole. quantitative easing and/or sharp escalation Any unexpected weakening of emerging in commodity and energy prices. We markets, however, in particular in the BRIC nevertheless view all three scenarios as very economies, would likely have a material unlikely over our rating horizon. l

Appendix: Major Rating Factors For European Corporate Sectors In 2012 Key Ratings Factors For European Corporate Sectors In 2012 Positive credit factors Main risks Utilities Active management of capital expenditure, Exposure to sovereign rating actions, due to continued deleveraging, and a focus on cost high share of government-related entities and efficiencies. Regulated utilities' cash flow high sensitivity to country risk. High political should be relatively stable. risks. High reinvestment needs with uncertain long-term return profile. Oil & gas Further refinery closures, restructuring, and Oil spike could stretch working capital and (refining) consolidation expected. liquidity. Refining margins remain weak in Europe. Steel Lower inventories than in 2008–2009, which Capacity utilization below 80% in Europe. should limit the amount of destocking. Potential squeeze between steel and raw material prices if China production remains high. Media Tight cost controls, with margins often close Potential declines in advertising rates in 2012 to pre-2009 levels. Accumulated rating could impact earnings. Entities absorbing headroom. More stable subscription-based debt-funded acquisitions or exposed to GIIPS revenues. regions have less financial flexibility. Shipping Gradually declining order books of new ships, Weakening demand and declining trade which should somewhat relieve oversupply in volumes. Structural oversupply. Excess capacity the near to medium term. is depressing rates and profits. Funding is becoming increasingly scarce and expensive. Building Maintenance and repair should be relatively Little industry recovery since 2009. materials recession-resilient. Cash flow still robust, Construction markets remain depressed. despite weaker earnings. Forest Capacity reduction likely in 2012, with some Weakening demand could impact volumes and products restructuring costs. Adequate to strong liquidity selling prices negatively. Mismatch of growth in most cases. Prospects for lower input costs. capital expenditure as the economy slows. Consumer Cost savings and working capital Retailers failing in austerity countries. Slowing products rationalization implemented over the past demand in emerging markets. Declining three years should counter weak consumption. market share due to underinvestment in new Commodity prices likely to be flat or declining. product development and marketing. Health Pharmaceuticals are well placed to balance Health care service providers exposed to care regulatory pressure and patent expirations with competition and regulation. new business and emerging-market growth. Aero & Multiyear order backlogs underpin outlook in Defense procurement spending set to decline defence civil aerospace. Production run rate for aircraft over time in Europe, while Middle East and should increase by 10%-15% in 2012 due to North Africa and emerging markets should see demand and new launches. continued growth. Capital Good order backlog to cushion the slowdown. Potentially more aggressive financial policies. goods Most companies able to stay free operating cash Less scope to cut inventory/working capital. flow-positive through the downturn.

A Guide To The European Loan Market february 2012 45 www.spcapitaliq.com Key Ratings Factors For European Corporate Sectors In 2012 (continued) Positive credit factors Main risks Autos- Industry still profitable if auto sales fall by 7%. Tier 1 suppliers may need to support Tier 2. suppliers Ratings should stay stable despite lower profits Margin pressure to weigh modestly on liquidity in 2012. in 2012.

Chemicals Margins to revert to midcycle in 2012, Volumes in 2012 expected to be down by as capacity utilization eases. Financial 5% (or by 10% in a severe recession), but performance in 2012 should be statisfactory destocking less severe than in 2008/2009, given strengthened cash flow generation/ when volumes fell by 20%–30%. Downward balance sheets over 2010-2011. revision to growth in China could create supply imbalances. Leisure Some companies have good headroom at the Maintaining liquidity and covenant compliance current ratings. Few short-term refinancing will be key. Travel, lodging, and U.K. pubs needs at the low end of the rating scale. vulnerable to consumer sentiment.

Retail Lower inflation could ease margin pressure. Ongoing austerity risks could undermine Stronger EU regions more resilient to adverse consumer confidence and damage sales. sector trends. Critical size and exposure to Competitive pricing to reduce profits in 2012. emerging markets likely to mitigate pressure in domestic markets. Hi Tech Solid liquidity provides underlying support, Weaker IT spend, owing to consumer and especially for investment-grade companies. government cutbacks. Weaker free cash Declines in EBITDA and operating cash flow flow, tightening covenant headroom and would be partly offset by lower working refinancing risk could put pressure on ratings capital needs. of highly leveraged credits.

Investment- Operating resilience and cash generation Sustained higher capital expenditure grade Telco largely expected to offset economic (spectrum auctions?) and aggressive (including pressures. Cable and emerging dividends policy. Refinancing risks for satellites) market operators should benefit from GIIPS telcos. positive demand.

Airports Efficiency improvements since 2009. Adequate Hubs are better protected than regional liquidity and some capital expenditure flexibility airports. Airline passenger taxes likely to hinder supports credit quality. growth. GIIPS airports on a privatization path.

Trans- Strong financial ratios compared to their Lower business confidence is likely to lead to a portation financial risk profiles should help material drop in high-yielding premium travel. (airlines) airlines cope with a significantly weaker Higher oil price. Recessionary pressures on operating environment. consumer discretionary spending.

Service Slow economic growth is positive for first time Continued outsourcing, but at lower margins. companies outsourcing. Emerging market acquisitions to Input cost inflation (wages, food), albeit more expand footprints. More complex service to constrained given weaker economic outlook. existing clients to maintain revenues. Liquidity adequate to strong in most cases. Packaging Our rated entities are quite reliant Volatility of energy and other input costs, but on more stable food and beverage expected to be more stable than in 2011 end markets. to the benefit of operating margins and working capital.

Oil & Gas We expect that our oil price assumptions for Large committed capital expenditure (upstream) rating purposes will remain at $90 per barrel programs likely to result in negative free in 2012. This will benefit operating cash flow operating cash flow in our view. Exposed to but partly reflects high capital expenditure and country and fiscal risks. lower return on capital.

REITs Geographic diversity and prime assets support Shrinking of property lending negatively recurring earnings. High portfolio quality impacts cost of refinancing and REITs' debt facilitates potential refinancing from various service. Rents likely to remain stable until sources. Development activities are limited in 2013, when pressured by economic issues. the current climate.

Toll Roads Stable cash flow generation. Long-term Economy-induced traffic declines could contractual framework with some protection damage credit metrics. Increased country risk against unforeseen events. in austerity countries (notably for Italian- based operators). Refinancing risk particularly if financial market disruption persists for an extended period in Europe.

46 Leveraged commentary & data february 2012 www.spcapitaliq.com Eurozone Risks Will Weigh On Corporates If They Can’t Find Growth Globally

Related Criteria And Research •• European Corporate Defaults Likely To Rise In 2012 On Gloomy Business And Financing Prospects, Jan. 18, 2012 •• European Economic Outlook: Back In Recession, Dec. 1, 2011 •• Can Luxury Goods Continue To Deliver Rich Returns In An Era Of Austerity?, published on Nov. 14, 2011 •• Why Basel III And Solvency II Will Hurt Corporate Borrowing In Europe More Than In The U.S., Sept. 27, 2011 •• How Well Positioned Are European Automakers For A 2012 Double-Dip?, Nov 8, 2011

A Guide To The European Loan Market february 2012 47 www.spcapitaliq.com The Future Of Corporate Funding: Filling The Leveraged Loan Gap In Europe

Primary Credit Analyst: efore the collapse of Lehman Brothers in September 2008, leveraged Taron Wade London Bloans were the engine of the leveraged finance market in Europe. The (44) 20-7176-3661 taron_wade@ market began a bull run in 2005, with issuance jumping by 180% to €119 standardandpoors.com billion in 2006 and then peaking at €165 billion in 2007, according to Secondary Contacts: Marc Lewis Standard & Poor’s Leveraged Commentary & Data. The speculative-grade London (44) 20-7176-7069 public bond market, however, remained mostly a side business, with marc_lewis@ volumes in 2007 only 14% of what loan issuance provided. standardandpoors.com

Paul Watters, CFA London (44) 20-7176-3542 Overview paul_watters@ •• The number of leveraged loan investors has been waning over the past two years standardandpoors.com in Europe. •• As a result, many companies have been turning to the speculative-grade public bond market. However, Standard & Poor’s believes that the bond market cannot supply all the capital that companies are seeking. •• In our view, there are three main options for filling the funding gap: the corporate high- yield bond market, which has already provided significant liquidity to help companies refinance existing loans; loans from retail investors; and institutional investors lending to companies (including subordinate loans, such as mezzanine loans).

But there is a paradigm shift occurring in number of maturing loans peaks (for more Europe’s capital markets. With the specter of details, see “ European Leveraged Loans Basel III on the horizon, financial institutions Face Funding Hiatus As CLO Vehicles’ are rethinking their commitment to lending Support Wanes,” published Aug. 22, 2011, on to speculative-grade companies (those rated RatingsDirect on the Global Credit Portal). ‘BB+’ or lower), including leveraged buyouts Over the past two years, the high-yield bond (LBOs) from private equity. At the same time, market in Europe has filled much of this Standard & Poor’s Ratings Services believes funding gap, helping LBOs to refinance exist- that specialist lending vehicles called collat- ing bank debt, as well as starting to wean eralized loan obligations (CLOs)—the primary leveraged companies off their reliance on source of new funding for European lever- loans. Although overall financing for lever- aged loans over the past decade—are aged transactions has dropped substantially unlikely to be available to support refinanc- since 2007, high-yield bond volumes have ing or new financing in the future. This is grown rapidly. In the past two years, high- because, in our view, the vast majority of yield bonds provided about 50% of the total European CLOs are likely to fall away as the financing to speculative-grade companies.

48 Leveraged commentary & data february 2012 www.spcapitaliq.com The Future Of Corporate Funding: Filling The Leveraged Loan Gap In Europe

Still, we believe that the high-yield bond or the public debt markets, banks can be the market cannot on its own fill the funding lenders of last resort. gap that reduced bank appetite and a Finally, it is easier to negotiate stagnant CLO market have left behind. We amendments with a bank group, even when believe that borrowers will continue to need a restructuring may be required, because a loans in their capital structures, and that bank with a strong ongoing relationship with asset managers will find a way to channel a borrower may be more willing to amend capital to revive this challenged market. We covenants or extend maturities. However, as think it’s just a question of who the ultimate the CLO market and hedge fund interest in participants will be. leveraged loans grew from 2001, accelerating in 2005, the number of institutional investors to speculative-grade Borrowers Have Historically companies grew at a rapid rate, as banks Favored Bank Loans preferred the underwrite-to-distribute Borrowers have traditionally favored loans model. By this model, banks do not take as a financing tool for several reasons. significant hold positions, but syndicate out First, they have a genuine need for bank the majority of their underwriting amount to funding, particularly for committed but other banks or funds, including CLOs and undrawn revolving credit facilities that they hedge funds. can use for working capital and as trade finance facilities. This is not the kind of credit financing that borrowers can get The Senior Secured Bond Market Has from the capital markets because most Been Companies’ First Port Of Call investors in bonds cannot provide overdraft Since Mid-2009 facilities. Borrowers also need term funding Banks have already demonstrated that they for activities such as capital expenditures, are keen to reduce their loan exposure where as well as for financing property, plant, and companies have funding alternatives. Since equipment. Through amortizing loan mid-2009, senior secured bond issuance has structures, banks are in the best position to grown to dominate the leveraged funding provide term funding when borrowers need markets, allowing existing senior lenders to to make staged repayments. be repaid from the proceeds of high-yield Second, bank credit generally is more debt issuance. Recent volatility in the high- consistent than the capital markets because yield market has meant that companies have market sentiment is volatile and windows of stopped using this market temporarily. opportunity to raise new debt issues can However, we believe that in the long term, the open and close suddenly. When companies speculative-grade bond market in Europe will lose access to the commercial paper market provide an increasing amount of liquidity for

Corporate Credit Rating Distribution Of Speculative-Grade Bond Issuers 2007–2011*

2007 2009 2010 2011

0.4 0.3 0.3 0.2 0.2 0.1 0.1 0.0 ‘BB+’ ‘BB’ ‘BB-’ ‘B+’ ‘B’ ‘B-’ ‘CCC’ (Corporate credit rating) *Data cover period from Jan. 1, 2007,to Dec. 31, 2007, and Jan. 1, 2009, to Nov. 30, 2011. (Issuance was negligible in 2008.) © Standard&Poor’s 2012.

A Guide To The European Loan Market february 2012 49 www.spcapitaliq.com companies facing upcoming debt maturities published Dec. 15, 2011, on RatingsDirect on and for new debt financing. the Global Credit Portal.) This trend has given lower-rated borrowers greater access to the public debt markets for the first time. In 2011, 61% of the companies Retail Investors Are A Big Missing tapping the high-yield bond market in Europe Piece Of The Funding Puzzle have had ratings in the broad ‘B’ category In the U.S., according to the Loan Market (that is, ‘B+’, ‘B’, or ‘B-’), compared with 50% Association, retail schemes account for 30% of in 2009 (see chart 1). In 2007, these U.S. primary leveraged loan volume. In Europe, companies comprised 44% of the rated however, this capital source remains untapped: universe. During the last economic cycle, Loans are ineligible assets for mutual funds or these types of companies relied heavily on open-ended investment companies (other the private loan market in Europe in the than as minority holdings in broad fixed- absence of an alternative. income portfolios) under the Undertakings for Of the newly rated companies in 2011, Collective Investment in Transferable Securities 80% were in the broad ‘B’ category, (UCITS). UCITS is the set of EU Directives for compared with only 46.9% of companies collective investment schemes. with existing Standard & Poor’s ratings. The Some market participants argue that the newly rated companies are small in size—on eligibility directive should change. In a average they had revenues of €1.7 billion response to an HM Treasury discussion and EBITDA of €240 million according to paper on nonbank lending in February 2010, the latest available 12-month figures. In the Association for Financial Markets in comparison, issuers with existing Standard Europe (AFME) argued that “widening the & Poor’s ratings in 2011 had average UCITS III definition of “eligible assets” to revenues of €8.8 billion and average EBITDA include loans is the single most significant of €1.2 billion. The new issuers in 2011 are measure policymakers could take to improve also predominantly owned by private equity. funding channels for U.K. companies.” Of the companies that we rated for the first Standard & Poor’s agrees that expanding the time in 2011, 54.2% were owned by private UCITS definition would be beneficial for equity, compared with 18.2% of companies increasing both the number of investors in that already had a Standard & Poor’s the market and liquidity. However, we believe public rating. this expansion should be subject to a level of As we would expect, leverage is higher increased disclosure for retail investors among companies with lower average similar to the U.S., where public companies corporate credit ratings. New issuers in 2011 are required to disclose financial statements had, on average, Standard & Poor’s-adjusted and loan documentation through Securities debt to EBITDA of 5.3x, compared with 4.8x and Exchange Commission filings. However, for companies with an existing rating in 2011. it is not clear at this moment who in the Although, in our view, the improved access market would take the lead to expand the that lower-rated companies have to the UCITS definition. public debt markets has been a positive Some investment managers have development for the corporate funding attempted to get around the issue of market, we do see implications for post- eligibility by issuing closed-end funds default recovery. In general, the trend for (collective investment schemes with a bank debt to be refinanced in the capital limited number of shares) that trade on markets is exposing investors to a greater stock exchanges and can give retail risk of loss after a default. When we compare investors access to loans. In 2010, senior secured bank debt with senior secured independent investment firm HarbourVest bond debt, the recovery prospects for senior started this trend with the establishment of secured bonds are almost a full category its Senior Loans Europe Ltd. vehicle, which lower than those for bank debt with an invested in middle-market loans. In April of equivalent rating. (For more information on this year, investment management firm the trends specific to the increase in the use Neuberger Berman raised more than $507 of the public bond markets in Europe, see million for its NB Global Floating Rate “Why Refinancing Bank Debt With Bonds In Income Fund, which was listed on the Europe Lowers Recovery Expectations,” London Stock Exchange (LSE).

50 Leveraged commentary & data february 2012 www.spcapitaliq.com The Future Of Corporate Funding: Filling The Leveraged Loan Gap In Europe

And in late October, Babson Capital Europe Although investors began pulling money out postponed plans to list its new global of the high-yield bond asset class in June floating-rate loan fund on the LSE, citing 2011, according to data from Emerging uncertainty in the European equity market. Portfolio Fund Research (EPFR), Western The fund, if and when it launches, will target European high-yield funds saw two weeks of a size of £125 million and will invest primarily record-high inflows in late October/early in secured loans with a 70% weighting to November since EPFR began tracking the European companies and 30% to U.S. market in 2004. And, according to press companies. The target annualized yield per reports, the number of mutual funds focused share is 6% in the first year and an annual on high-yield debt has doubled since the gross total return of 8%–11%. 2008 crisis. While these workarounds have been effective so far, being subject to volatile market conditions has been a big drawback The Leveraged Finance Market Will for listed investment vehicles. In addition, Eventually Become More Diverse there is reputational risk for listed funds if In the near term, we believe that, despite they trade below their net asset value. present market volatility, the corporate high- yield bond market will be the main part of the solution to the leveraged loan funding gap. Mezzanine Loans Could Support Private The high-yield market is already in place, Lending, But They’re Likely To Remain A disclosure exists to some extent, and funds Niche Product have already been set up, particularly those We think mezzanine loans—a type of that capitalize on the demand from retail subordinated loan—can support the investors to gain exposure to credit. continued development of the loan market in However, in the long run, we believe that Europe. However, we expect that they’ll most the leveraged loan market will revive and likely remain a niche product for specific provide a portion of funding, but that it is transactions that are not suitable for the likely to look much different than it does high-yield bond market or for use when the now. Although we anticipate that the vast high-yield bond market is shut, as has been majority of European CLOs are likely to fall the case in recent months. away over the next few years, there is still The recent use of mezzanine finance to quite a high percentage of institutional take out some of the bond bridges put in investors that are not CLOs investing in place before the summer’s volatility has given primary transactions, which shows that hope to many that the market will return in there is still interest from institutional full force. For example, in early December lenders in the asset class. To the end of 2011, Coditel Holding Lux Sarl (B/Stable/—) September 2011, 26% of institutional completed a €250 million senior loan and investors were made up of credit funds. mezzanine financing, which replaced a bond And, according to market participants, there bridge. And in late August 2011, Securitas are new investors interested in the asset Direct (not rated), used the mezzanine class—including insurance companies and market to raise €393.5 million in pension funds. subordinated financing. However, we believe In addition, asset manager consolidation of this practice is only a short-term stop-gap existing CLOs may give more of these asset until the high-yield bond market opens up managers economies of scale to continue to again. Mezzanine financing historically is at a invest in leveraged loans through non-CLO record low. The volume this year to Oct. 31, funds—either on a less-leveraged or non- 2011, is €880 million, down from €1.19 leveraged basis. Examples of such billion in 2010 and €0.99 billion in 2009, and consolidation of existing CLOs include Ares much lower than the €6.36 billion in 2008 Management LLC acquiring Indicus Advisors and the record-high €12.76 billion in 2007, in August 2011, following its acquisition of according to LCD. Octagon Credit Investors LLC earlier in the We believe that, in the near term, high- year, and Rothschild Group’s acquisition of yield issuance will remain less expensive for Elgin Capital LLP. Existing mezzanine funds borrowers and therefore more attractive a may also expand their investment remits to financing option than mezzanine debt. lend on a senior secured basis.

A Guide To The European Loan Market february 2012 51 www.spcapitaliq.com Overall, we foresee that there will be a Related Criteria And Research broader mix of investors in leveraged loans. •• Special Report: Leveraged Debt In 2012: Where there is appetite for credit, we believe The Markets Are Open, But Credit Risk that fund managers will come up with creative Remains, Jan. 23, 2012 ways of investing the money, as they have with •• Why Refinancing Bank Debt With Bonds the advent of closed-end funds. We expect low In Europe Lowers Recovery Expectations, interest rates to persist for some time, which Dec. 15, 2011 we think will encourage investors—including •• European Leveraged Loans Face Funding retail investors in time—to seek exposure to Hiatus As CLO Vehicles’ Support Wanes, speculative-grade credit. l Aug. 22, 2011

52 Leveraged commentary & data february 2012 www.spcapitaliq.com Why Refinancing Bank Debt With Bonds In Europe Lowers Recovery Expectations

Primary Credit Analysts: uropean capital markets are increasingly financing speculative- Taron Wade London Egrade companies, a trend that began in mid-2009 when bank (44) 20-7176-3661 taron_wade@ financing dried up in the global financial crisis. Although recent volatility standardandpoors.com in the debt markets is temporarily preventing speculative-grade Marc Lewis London companies from accessing bond finance, Standard & Poor’s Ratings (44) 20-7176-7069 marc_lewis@ Services believes the speculative-grade bond market in Europe will standardandpoors.com continue to provide liquidity for companies looking to refinance Secondary Contact: David Gillmor upcoming debt maturities and issue new debt. However, we note that London post-default recovery prospects are lower on speculative-grade bonds (44) 20-7176-3673 david_gillmor@ than their equivalent loans, largely because certain structural features standardandpoors.com of bonds lead to lower recoveries compared to loans. Additional Contact: Industrial Ratings Europe CorporateFinanceEurope@ standardandpoors.com Overview •• Financial institutions across Europe are less committed to lending to speculative-grade companies in light of Basel III. •• At the same time, we believe that specialist lenders to leveraged companies— collateralized loan obligations (CLOs)—will not be available to support refinancing or new financing in the future. •• We therefore see the public debt markets taking a bigger role in financing leveraged companies in the region. •• However, the introduction of more complex capital structures in refinancings is reducing post-default recovery prospects for bondholders.

The Speculative-Grade Bond Market new funding for European leveraged loans Is Filling The Funding Gap over the past decade—will not be available to Financial institutions are rethinking their support refinancing or new financing in the commitment to lending to speculative-grade future. This is because, in our view, the vast companies given that Basel III is introducing majority of European CLOs are likely to fall the need for banks to hold more capital on away as the number of maturing loans peaks their balance sheets. At the same time, we (for more details, see “European Leveraged believe that the specialist lending vehicles, Loans Face Funding Hiatus As CLO Vehicles’ called collateralized loan obligations, to lev- Support Wanes,” published Aug. 22, 2011, on eraged companies—the primary source of RatingsDirect on the Global Credit Portal).

A Guide To The European Loan Market february 2012 53 www.spcapitaliq.com As a result, we believe the public debt leveraged transactions, which has dropped markets will play an increasing role for substantially since 2007. By way of leveraged companies in Europe in the future. illustration, speculative-grade bond For a more detailed look at the broad shift in volumes rose rapidly over this period, corporate funding for leveraged credits in providing about 50% of the total financing Europe, see “The Future Of Corporate needs for speculative-grade companies in Funding: Filling The Leveraged Loan Gap,” 2009 and 2010, according to issuance data published Dec. 15, 2011, on RatingsDirect on from Standard & Poor’s Leveraged the Global Credit Portal. Commentary & Data. This is in sharp Banks have already demonstrated that contrast to the peak of the market in 2007, they are keen to reduce their loan when bonds provided only 12% of these exposures where companies have funding companies’ total funding needs. alternatives. Since mid-2009, senior In the past, Standard & Poor’s rated secured bond issuance has dominated the universe of speculative-grade corporates was high-yield funding markets, allowing dwarfed by the number of companies raising existing bank investors to be repaid at the funds in the private bank market in Europe. senior secured level. So far in 2011, however, 61% of the Leveraged buyout (LBO) targets and companies tapping the speculative-grade highly leveraged corporates both benefit bond market in Europe were in the ‘B’ rating from the speculative-grade bond market to category (that is, with long-term corporate refinance existing bank debt in their capital credit ratings of ‘B+’, ‘B’, or ‘B-’), up from structures, in our view. For example, in April 50% in 2009 (see chart 1). In 2007, these 2011, we upgraded Carmeuse Holding S.A. companies comprised 44% of the rated (BB-/Stable/—) after reassessing its universe. But this trend has implications not business risk profile and also because it only in terms of the credit risk of companies refinanced its credit facilities with senior tapping the market, but also for recovery secured notes and a revolving credit facility expectations post default. (RCF). The refinancing enabled us to revise In the nine months to September 2011, our view of the company’s liquidity position to before bond market volatility arising from the “adequate” from “less than adequate” sovereign debt crisis in the European because it created a much improved debt Economic and Monetary Union (eurozone) maturity profile and liquidity position. effectively closed down speculative-grade Proceeds from the new bond and revolver issuance, 47% of new speculative-grade refinanced Carmeuse’s senior credit facility, issuance was in the form of secured bonds. which was due to mature in 2011-2013. This compares with only 21% in 2006. We Companies have tapped the speculative- believe this is part of a broader generic grade bond market primarily in response to change in speculative-grade companies’ the decline in loan financing available for capital structures. In previous structures

Chart 1 | Corporate Credit Rating Distribution Of Speculative-Grade Bond Issuers 2007–2011*

2007 2009 2010 2011

35 30 25 20 15 10 5 0 ‘BB+’ ‘BB’ ‘BB-’ ‘B+’ ‘B’ ‘B-’ ‘CCC’ (Corporate credit rating) *Data cover period from Jan. 1, 2007,to Dec. 31, 2007, and Jan. 1, 2009, to Nov. 30, 2011. (Issuance was negligible in 2008.) © Standard&Poor’s 2011.

54 Leveraged commentary & data february 2012 www.spcapitaliq.com Why Refinancing Bank Debt With Bonds In Europe Lowers Recovery Expectations

where bonds refinanced loans, senior secured million in unsecured notes and a €50 million bonds sat alongside senior secured loan super senior RCF. facilities ahead of other subordinated debt. But now, in the majority of transactions (54.3% in 2011 year-to-date), senior bank The Use of Bond Financing Increases debt is being refinanced entirely with bonds, Recovery Risk For Investors in addition to a super senior revolving credit In our opinion, these structures are exposing facility (RCF). For example, we assigned a investors to a greater risk of loss post recovery rating of ‘4’ to the £300 million default. Comparing the recovery prospects and €200 million senior secured notes of senior secured bank debt against senior issued by Odeon & UCI Finco PLC (a secured bond debt, we see recovery subsidiary of Odeon & UCI Cinemas Group prospects for senior secured bonds being Ltd.; B/Stable/—) in June. The company almost a full category lower than the refinanced its entire debt structure with the equivalently ranked bank debt. Our data senior secured notes plus a £90 million super show that the average recovery rating for senior RCF. In some cases, companies speculative-grade senior secured bank debt include subordinated debt ranking below the rated in the first eleven months of 2011 was senior debt. Ontex IV S.A. (B+/Stable/—), for 2.5 (55 transactions), compared with 3.3 instance, issued €600 million in senior (41 bonds) for senior secured bond secured notes in March alongside €235 transactions. Furthermore, recovery ratings

Chart 2 | Distribution Of Recovery Ratings Assigned To Speculative-Grade Bonds Issued In 2011*

Senior secured debt Senior unsecured debt Subordinated debt (No. of ratings) 20 18 16 14 12 10 8 6 4 2 0 1+ 12 3456 (Recovery rating)

*Data cover period from Jan. 1, 2011, to Nov. 30, 2011. © Standard&Poor’s 2012.

Chart 3 | Distribution Of Recovery Ratings On Speculative-Grade Loans In 2011*

Senior secured debt Senior unsecured debt Subordinated debt (No. of ratings) 30

25

20

15

10

5

0 1+ 123456 (Recovery rating)

*Data cover period from Jan. 1, 2011, to Nov. 30, 2011. © Standard&Poor’s 2012.

A Guide To The European Loan Market february 2012 55 www.spcapitaliq.com on bonds are skewed more toward recovery debt markets is a positive development for rating categories ‘3’ (50%-70% recovery in the corporate funding market, in our opinion. the event of a payment default) and ‘4’ We believe it gives speculative-grade (30%-50% recovery), whereas those for companies access to a larger pool of liquidity loans are more typically in recovery rating and therefore increases the level of flexibility categories ‘2’ (70%-90% recovery) and ‘3’ they have to manage their debt maturity (see charts 2 and 3). profiles. However, there may be implications We believe that one of the reasons for for post-default recovery expectations, lower potential recovery prospects on bonds particularly due to the new structural features is that capital structures include additional of recent transactions. For bond investors, the layers, with RCFs typically holding a super opportunity to increase lending carries the senior claim on the collateral. This creates a risk of lower recoveries on bonds compared to higher degree of subordination for bonds loans. As a consequence, recovery analysis compared to loans, where the RCF typically will become increasingly important as the ranks pari passu. Also, we note that bank speculative-grade bond market in Europe loans are more frequently structured on an continues to grow and evolve. l amortizing basis, which helps to support recovery prospects because outstanding debt reduces compared to the bullet payment Related Criteria And Research structures typical of bonds. All articles listed below are available on In addition, we find that in many cases RatingsDirect on the Global Credit Portal companies are using refinancing to increase unless stated otherwise. the proportion of senior secured debt in their •• Special Report: Leveraged Debt In 2012: capital structures. This reduces the likely The Markets Are Open, But Credit Risk recoveries post default, particularly where Remains, Jan. 23, 2012 stressed valuations are low. •• The Future Of Corporate Funding: Filling The Leveraged Loan Gap, Dec. 15, 2011 •• European Leveraged Loans Face Funding Recovery Analysis Moves To The Fore Hiatus As CLO Vehicles’ Support Wanes, Assuming that the current volatility caused by Aug. 22, 2011 the eurozone crisis subsides and that the •• Looking At The Differing Recovery Profiles bond markets return to normal, in the long Between Secured Notes And Secured run, the fact that lower-rated companies in Loans, Dec. 7, 2010 Europe now have better access to the public

56 Leveraged commentary & data february 2012 www.spcapitaliq.com European Leveraged Loans Face Funding Hiatus As CLO Vehicles’ Support Wanes

Structured Credit Analysts: ollateralized loan obligation (CLO) transactions have been the Emanuele Tamburrano London Cprimary source of new funding for European leveraged loans over (44) 20-7176-3825 emanuele_tamburrano@ the past decade. But as many of these loans are set to mature in the standardandpoors.com near future, will the CLO market be around to offer support in Sandeep Chana London refinancing them? The evidence suggests that it won’t, so in the (44) 20-7176-3923 sandeep_chana@ absence of alternative funding, many corporate borrowers are left standardandpoors.com facing a potential funding gap. Over the period 2011 to 2015, €69 Corporate Credit Analyst: Paul Watters, CFA billion of European CLOs by par amount will have ended their London reinvestment periods, while over the same period, up to €61 billion of (44) 20-7176-3542 paul_watters@ European leveraged loans held within CLO portfolios will need to be standardandpoors.com refinanced. (Watch the related CreditMatters TV segment titled, Additional Contacts: Structured Finance Europe “European Leveraged Loan Funding Could Dry Up As CLO Support Falls,” StructuredFinanceEurope@ standardandpoors.com dated Aug. 25, 2011.) Industrial Ratings Europe CorporateFinanceEurope@ standardandpoors.com The broadening of the institutional investor when a significant number of maturing loans market over the past decade has been the will require refinancing in the near future. Vedant Thakur Mumbai fuel behind Europe’s leveraged finance The concern is a valid one, in our view. Our (91) 22-4040-1930 growth, in Standard & Poor’s Ratings data suggest that in the next few years, vedant_thakur@ Services’ opinion. Among such investors, leveraged loans underlying CLOs could face a standardandpoors.com structured finance vehicles such as CLOs— funding shortfall as existing European CLOs which invest primarily in loans made to start to end their reinvestment periods, speculative-grade companies—have causing their reinvestment rates to contract been a material source of investor funding sharply. Over the course of 2015, for example, supporting this rapid rise, providing up to about €23.3 billion of leveraged loans held by 63% of overall institutional loan funding CLOs will require refinancing—but at a time in 2007. when a significant number of existing CLOs Consequently, the significance of the CLO have ended their reinvestment periods, investor in today’s leveraged loan market has effectively limiting the ability of such vehicles recently led market participants to focus from refinancing maturing loans. their attention on the maturity profile of To assess the extent of this potential loans underlying European CLO transactions. funding shortfall, we reviewed the collateral In particular, there is growing concern as to portfolios of 205 European cash flow CLOs at whether CLOs will be able to support the the end of each year between 2008 and European leveraged loan market at a time 2010. We observe that during these three

A Guide To The European Loan Market february 2012 57 www.spcapitaliq.com years the weighted-average maturity profile From our perspective, private equity of loans underlying European CLOs increased, investors were the main catalyst for this indicating to some extent that leveraged loan growth, as they identified the opportunity to borrowers have been refinancing their loans. create attractive returns by buying ever- Looking ahead, however, our data suggest larger companies and structuring them as that the vast majority of European CLO leveraged buyouts (LBOs). In fact, according transactions are likely to fall away from the to Standard & Poor’s Leveraged Commentary leveraged finance market at the very time the & Data (LCD), on average 86% of primary wave of maturing loans crests. And with the leveraged loan activity in Europe between prospect of little-to-moderate new CLO 2005 and 2007—when activity was at its creation and a general paucity of loan and peak—was private equity-sponsored. Of capital market credit in Europe, this could course, the success of the LBO business leave many borrowers short in the coming model also depended on the provision of years, possibly leading to a second spike up sufficient, cost-effective debt financing. in leveraged loan defaults in Europe. Back in 2003–2007, the banking community, together with the growth of alternative investors, had sufficient liquidity and CLO Vehicles Fueled Leveraged Loan appetite to facilitate the significant growth Expansion In The Past Decade that the leveraged loan market experienced The development of the European leveraged at that time. finance market over the past 10 years has As shown in chart 1, the growth of the reflected the rapid rise to prominence of large institutional loan market was a major factor private equity firms and their subsequent supporting the rapid growth of LBO activity in retrenchment, given their heavy reliance on Europe. Institutional investors provided only the availability of debt financing to support about 10% of leveraged loan financing in their business models. As illustrated in chart 2001, but over the next six years their share 1, the annual issuance of senior loans in the of primary loan market activity grew to 67% leveraged finance market quadrupled to €166 by the time the market peaked in 2007. CLO billion in 2007, from €41 billion in 2002. To vehicles have been the most important type put that in context, the consolidated gross of institutional investor over the past decade, debt of Sweden today is about €151 billion, providing up to 63% of overall institutional according to the European Commission. loan funding in 2007 (see chart 1).

Sidebar 1 | Leveraged Loan Market Faces Funding Shortfall •• CLOs have been a material source of investor funding in European leveraged finance in recent years. •• A significant number of the underlying loans in CLO transactions are scheduled to mature in the near future, and are likely to require refinancing. (This potential shortfall would be lower to the extent that a number of CLOs are still able to reinvest unscheduled principal proceeds after their reinvestment periods have ended, as well as certain sale proceeds during the same period. Also, a limited number of CLO managers may receive consent to extend a CLO’s reinvestment period.) •• We believe that the vast majority of European CLOs are likely to fall away as the number of maturing loans peaks. •• As such, there is growing concern as to whether CLOs are able to support maturing leveraged loans in the coming years. Our review covers 205 Standard & Poor’s-rated European cash flow CLOs. Our analysis of CLO reinvestment potential is based on the reinvestment periods of CLOs (as defined by their documentation) and the scheduled amortization of the underlying loans in CLO portfolios. We do not take into account the potential for loans to prepay in whole or in part, and subsequently do not account for the possibility of future reinvestments by CLO managers. Our analysis also excludes the sale of loans during the reinvestment period by CLO managers, and any existing principal cash proceeds held by CLOs.

58 Leveraged commentary & data february 2012 www.spcapitaliq.com European Leveraged Loans Face Funding Hiatus As CLO Vehicles’ Support Wanes

Leveraged Loan Maturities Peak of the leveraged loans advanced in peak In 2015, Just As All Existing CLO years of 2006 and 2007 have started to Support Wanes mature. Our data indicates that borrowers have had some success in refinancing their As chart 2 indicates, in 2014 and 2015 there is loans as the weighted-average maturity of a concentration of leveraged loans maturing loans in CLO pools we rate has risen over the at a time when a significant batch of existing past three years. Looking forward, though, CLOs are—according to their governing the picture isn’t quite so hopeful. documents—unlikely to be able to offer fresh In Appendix 4, we give a deeper breakdown finance. We expect the potential concerns of which industries and countries could surrounding refinancing are likely to be further experience the biggest funding pressures. exacerbated by other pressures in the CLO market (which we discuss below) and by the general refinancing difficulties currently What’s Restricting CLO Refinancing? existing in the global capital markets. So why is CLO participation in the refinancing Leveraged loans generally, and those of leveraged loans likely to be limited over the underlying CLOs specifically, routinely require next few years? Primarily, as chart 3 shows, refinancing. The average tenor of a leveraged this is due to CLO reinvestment periods end- loan is about 6–7 years, meaning that many

Chart 1 | Annual Primary European Senior Leveraged Loan Volume—Bank Versus Institutional Investor Share

Institutional loan volume Bank loan volume Institutional investor share(%) (left scale) (left scale) (right scale)

(Bil ¤) (%) 180 80 160 70 140 60 120 50 100 40 80 30 60 40 20 20 10 0 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: S&P Capital IQ LCD. © Standard&Poor’s 2012.

Chart 2 | European CLOs—Asset Maturity Profile

Maturity profile of assets held within CLOs Principal balance of CLO portfolios ending their reinvestment period

(Bil ¤) 8 7 6 5 4 3 2 1 0

3

3

3

3

3

1

1 1

Q3

Q3 Q3

Q3

Q1

Q1

Q1

Q1

3

9 Q 4 Q

0 Q 5

6 Q 1

7 Q 2 Q3

8

7

8

9 Q 4

5 Q

6

2 Q1

3 Q1

0 Q

1 Q1

201

201 201

202 201

201 201

201 201

201

201

201

201 201

201

201

201

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202

201

Source: S&P Capital IQ LCD. © Standard&Poor’s 2012.

A Guide To The European Loan Market february 2012 59 www.spcapitaliq.com Sidebar 2 | Reinvestment In Practice—The Three Stages Of A Typical CLO ypically, a managed CLO’s timeline to maturity would flow through three distinct phases: T The ramp-up period, the reinvestment period, and the amortization period (i.e., after the reinvestment period). The ramp-up period. Unlike the majority of traditional structured finance products, CLO new issuance is typically not fully “ramped” on the closing date of the transaction. Historically, 60%–70% of the CLO portfolio would have been identified and purchased, with the remaining portion being purchased after the transaction closes according to investment guidelines. Once the portfolio is 100% “ramped up,” it is “effective.” It is generally at the effective date where the CLO’s reinvestment period begins. During the reinvestment period. Among other factors, the CLO offers a protracted reinvestment period, which aims to ensure a material source of financing, mainly to European corporate borrowers who generally carry speculative-grade ratings. During this specified period, CLO managers can sell and reinvest assets in an effort to improve the portfolio’s credit quality. For example, the proceeds received from the scheduled repayment of a loan—whether in full or in part—can be redeployed in another loan by the CLO manager, so long as specified guidelines are met. In this way, the CLO remains reinvested. Most European cash flow CLO documents provide specified guidelines (typically referred to as the “reinvestment criteria” in transaction documents) that allow CLO managers to make changes to their portfolios during the CLO’s reinvestment period. For example, a CLO manager would typically be allowed to reinvest provided that: •• No event of default is occurring, •• Investment guidelines are satisfied or not made worse, •• Weighted-average coupon/weighted-average spread tests are maintained or improved, •• The weighted-average life test is maintained or improved, •• The weighted-average recovery rate tests are maintained or improved, •• Standard & Poor’s CDO Monitor Test is maintained or improved, •• Other NRSRO (Nationally Recognized Statistical Rating Organization) tests are not breached, and •• The par balance of the CLO is no lower than before the reinvestment was made. •• A CLO manager would typically have the following types of proceeds at hand with which to reinvest: •• Scheduled principal redemptions (repayments), •• Recoveries received from the sale of defaulted assets, •• Unscheduled principal redemptions (prepayments), •• Credit-improved sales, •• Credit-impaired sales, •• Discretionary sales/purchases, and •• Circumstances where interest is characterized as principal (for example, following the failure of a typical reinvestment OC test). In certain situations, CLOs may reinvest proceeds only on a limited basis during the rein- vestment period. For instance, if the CLO breaches one or more of its OC tests, this would generally result in a de facto end of the reinvestment period until the tests are back in com- pliance. In this instance, a CLO manager would generally use any scheduled principal repay- ments received from the underlying loans to redeem its liabilities in their order of priority. However, transaction documents would still typically allow CLOs to reinvest unscheduled prin- cipal proceeds so long as they meet covenant restrictions, even when OC tests are in breach. Amortization period—after the reinvestment period. Following the end of the reinvestment period, in general scheduled principal proceeds received by the CLO from its underlying investments would be used to redeem its liabilities in order of priority. In some cases, however, CLOs may still reinvest unscheduled principal proceeds, provided that reinvestment guidelines continue to be satisfied (for example, where the maturity date of the new loan being purchased is no greater than the maturity of the loan that prepaid, or the maturity of the new loan does not exceed the maturity of the CLO’s liabilities).

60 Leveraged commentary & data february 2012 www.spcapitaliq.com European Leveraged Loans Face Funding Hiatus As CLO Vehicles’ Support Wanes

ing, which is likely to limit CLOs from rein- of 2014, a significant number of outstanding vesting in leveraged loans, in our opinion. CLOs will have exited their reinvestment Added to this, we believe that several periods, which is likely to mean a sharp technical reasons may also inhibit the CLO decline in CLO reinvestment rates in market’s participation: leveraged loans. •• First, many CLOs governing documents Considering all CLOs that were within their restrict reinvestment following a down- reinvestment periods at the beginning of this grade of the CLO’s notes; year, in 2011 alone, 15% of existing European •• Second, other restrictive reinvestment CLOs by par amount (as of the end of 2010) guidelines that limit CLOs from reinvesting will enter their amortization periods. This is in leveraged loans; and followed by an additional 27.5% of CLOs that •• Third, many subordinated CLO notehold- are set to mature throughout 2012. By the ers have the option to redeem their notes end of 2013, existing CLOs still within their under certain conditions, which could— reinvestment cycle will have dropped by if those circumstances arise—hasten 72.6%, with a further 29.7% of CLOs exiting the end of the CLO even before its reinvestment over the course of that year. reinvestment period ends. 98.6% of existing CLOs covered by our Lastly, we have witnessed a fall-off in dataset will have entered amortization phase new CLO creation in recent years, meaning by the end of 2014. that we would have to see a steep rise in In terms of count, 22 CLOs will exit their new CLO issuance in Europe in order to plug reinvestment periods by the end of this year. the potential gap left by the restrictions Over the course of 2012, the number of CLOs on existing CLOs (see “What Could Fill ending their reinvestment periods will more Leveraged Finance Refinancing than double, with 49 European CLOs entering Needs?” below). amortization. The highest number of CLOs ending their reinvestment periods—50 Existing CLOs’ reinvestment periods are ending European CLOs that we rate—will exit During the reinvestment period, CLO reinvestment in 2013 (see chart 3). managers can refinance existing loans in the CLO’s portfolio or trade new loans for CLO reinvestment guidelines may also constrain existing ones, typically subject to pre- existing CLOs from providing refinancing agreed guidelines. Once this period ends, assistance to leveraged loan borrowers however, this practice usually stops and the We believe certain reinvestment guidelines portfolio remains almost static until the may also potentially limit a CLO’s capacity to CLO’s notes mature (see sidebar 2 below provide necessary leveraged loan refinancing. for further details). In certain situations, CLOs may reinvest Our study shows that a majority of existing proceeds only on a limited basis during the European CLOs will exit their reinvestment reinvestment period. In sidebar 2, we provide periods between 2012 and 2014. By the end examples of the sort of reinvestment

Chart 3 | European CLOs—Reinvestment Period End Dates By Quarter

(No. of deals) 18 16 14 12 10 8 6 4 2 0

Q4

Q4

Q4 Q4

Q3

Q3

Q3 Q3

Q2

Q2

Q2 Q2

Q1

Q1 Q1

Q1

2017

2014 2008

2011

2006

2015 2009

2012

2007

2013

2016 2010

2008

2017

2014

2011 (Quarter)

© Standard&Poor’s 2012.

A Guide To The European Loan Market february 2012 61 www.spcapitaliq.com guidelines with which CLOs would generally sale of defaulted and credit-impaired or need to comply to continue reinvesting in credit-improved loans as the CLO manager leveraged loans. Typically, if the CLO deems appropriate. This also applies even if breaches one of the guidelines, this would the CLO is compliant with all coverage tests generally end—or at a minimum curtail—the and all other reinvestment guidelines. reinvestment period until the CLO is back in compliance. As of the end of April 2011, 17% Redemption at the option of subordinated of the European CLOs covered by our dataset CLO noteholders (which represents 35 CLOs covered by our A significant number of CLO documents dataset, four of which are failing their senior include provisions where the issuer of a CLO overcollateralization [OC] tests and 31 failing may call the transaction if requested by junior OC tests) are currently failing at least subordinated noteholders (typically, the equity one coverage test, indicating that CLOs noteholders). This would result in all proceeds ending their reinvestment periods is not the held by the CLO being applied to redeem all only factor that could limit a CLO from outstanding classes of notes, often in providing refinancing assistance to the accordance with the CLO’s priorities of leveraged loan investor base. payments. The option to call a CLO transaction by subordinated noteholders is typically Reinvestment restrictions following a downgrade subject to the transaction satisfying specified A further deterrent that may prevent requirements, as detailed in sidebar 3. reinvestment, regardless of where the CLO In our view, subordinate noteholders sits in its timeline. Some transaction exercising their option to call CLO documents prevent CLOs from reinvesting transactions would result in CLOs exiting the any type of principal proceeds if the ratings institutional market sooner than expected, on the notes issued by the vehicle have been potentially further exacerbating refinancing negatively affected by rating actions. For risk for leveraged loan borrowers. We believe instance, if the ratings on the senior notes of that CLO redemption could therefore result in a CLO falls by more than one notch and the a sharp contraction of the institutional rating on the junior notes by several notches, investor base (as opposed to CLOs naturally then in general a CLO manager would be amortizing toward maturity), which could prevented from reinvesting in additional significantly limit the choices available for loans and may only be able to engage in the funding the leveraged finance market.

Sidebar 3 | Optional Redemption Of A CLO enerally, the issuer may call a CLO transaction on behalf of the subordinated Gnoteholders only after a specified period has ended, typically represented as the “non- call period” in CLO transaction documents. Based on the universe of CLOs in our study, the non-call period generally ranges from 3–5 years, starting from the closing date of the CLO. Subordinated noteholders are not able to exercise their option to call for redemption during this time. Following the end of the non-call period, subordinated noteholders may exercise their option for redemption of all classes of notes at any time thereafter provided that certain generic guidelines are met: •• A majority of subordinate noteholders must have requested the redemption. CLO guide- lines typically state that a predefined percentage of subordinated noteholders by the current principal amount of the liability would be required in order to request redemption of all classes of notes. In most instances, majority noteholder consent would be required to satisfy this quorum—for instance, a request in writing of two-thirds of the aggregate principal amount of the class subordinate notes then outstanding would be required to redeem all classes of notes. •• The proceeds realized following liquidation of the underlying loans held by the CLO (together with any remaining proceeds held in the CLO’s accounts) must be sufficient to fully repay all noteholders, including accrued interest, in accordance with the CLO’s priorities of payments.

62 Leveraged commentary & data february 2012 www.spcapitaliq.com European Leveraged Loans Face Funding Hiatus As CLO Vehicles’ Support Wanes

Results from our study show that, so far, From a leveraged finance perspective, a 129 out of the 205 existing CLOs covered legacy of the recent recession is a by our study have ended their non- fundamentally different funding environment, call periods. namely a significant reduction in the 62 existing CLOs ended their non-call availability of debt finance for leveraged loan periods during 2010. A further 56 CLOs, issuers. This will, in our view, present which represent 27% of the CLOs in our challenges for more vulnerable, typically study, will end their non-call periods by the smaller, leveraged loan issuers that will need end of this year—bringing the total to 185 to refinance over the next two to four years. CLOs (or 90% of the dataset) having the Nonetheless, at least until a few weeks ability to exercise redemption. ago, the funding picture had been quite While we do not view optional redemption supportive for borrowers, judging by Q2 as an immediate or even a direct risk to the 2011’s €16 billion primary leveraged loan leveraged loan community, we believe that volume (the highest level since Q3 2008 this potential scenario is an important factor according to S&P Leveraged Commentary for market participants to bear in mind over and Data [LCD]). This largely reflected 2006- the longer term. 2008 vintage loan issuers taking advantage of a temporary increase in investor liquidity to refinance. The importance of the high- What Could Fill Leveraged yield market cannot be overstated in this Finance Refinancing Needs? context. Specifically, at least 30% of new It is instructive to try to estimate the size European high-yield issuance during the first of any potential financing gap by reviewing half of 2011, or almost €9 billion, has been the maturity profile of existing leveraged raised to refinance leveraged loans. This has loan issuers. helped to de-risk the banks and provided CLO By our calculations, the volume of investors with funds to reinvest. This renewed leveraged loans maturing in Europe from investor appetite for loans has facilitated an 2011–2017 totals approximately €250 increase in loan refinancing activity, billion. To arrive at this figure, we used particularly where the institutional maturity leveraged loan data from Dealogic component can be increased while the pro as of December 2010, so excluding new rata bank element is reduced. The refinancing 2011 primary loan volume, and assumed by Kabel Deutschland in June 2011 is a good prepayments in line with those for our example where a bond issue and a new European Leveraged Loan Index as of June seven-year institutional term loan essentially 2011. As shown in chart 4, we anticipate that refinanced the revolver, PIK loan, and much the peak for loan maturities will be about of the existing Term Loan A. €67 billion in each year, in the absence of On the other hand, we believe that earlier refinancing. European banks are exhibiting caution in

Chart 4 | Estimated Debt Maturity Profile Of Leveraged European Issuers

Leveraged buyout loans maturing* Speculative-grade bonds maturing

(Bil. ¤) 120

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0 2011 2012 2013 2014 2015 2016 2017 *Includes all senior and subordinated issuance assuming prepaymentsin linewith Standard &Poor’s European Leveraged Loan Index. Note: Europe covers EU-27 countries, Iceland, Norway, and Switzerland. Sources: Dealogic and Standard&Poor’s Leveraged Commentary&Data. © Standard&Poor’s 2012.

A Guide To The European Loan Market february 2012 63 www.spcapitaliq.com their appetite for lending to highly leveraged Second, we believe that CLOs face the enterprises, and, wherever possible, continue significant head-winds of risk retention rules to prioritize managing down their exposure to as outlined in Article 122a of the European 2006–2008 vintage LBOs, particularly for Union Capital Requirements Directive. Since those with weaker credit characteristics. CLOs are viewed as major lenders to the Rising capital charges, high wholesale European leveraged finance market, the funding costs, and capital scarcity are “skin in the game” directive is likely to mean expected to continue weighing on European a significant reduction in CLO creation in the banks’ willingness to commit leveraged future, severely limiting the debt funding corporate loans to their balance sheets. In options for potential leveraged loan issuers this context, it is notable how dependent in Europe. arrangers are on institutional liquidity rather than other banks to sell down their loan exposures. Until the recent market setback, Appendix 1: Overview Of arrangers were even starting to provide European Leveraged Loan Market delayed settlement facilities to institutional Standard & Poor’s perspective on corporate credit quality investors in anticipation of investors reinvesting future prepayments. Under our base case, we anticipate that We expect European CLO issuance to economic growth will remain positive in remain muted for some time, which means Europe through 2011 and into 2012. that CLO technology is unlikely to generate any However, it is likely to be subdued with meaningful funding for new leveraged buyout significant variations between countries while transactions going forward. In our view, two the downside risks caused by the escalating main drivers support this conclusion. eurozone sovereign crisis are increasing. First, CLO economics in Europe are still In relation to the north-south divide, we not attractive enough to provide the would expect Northern European countries— arbitrage necessary for new CLO led by Germany, with a highly competitive transactions, given high CLO note margins industrial base and relatively sound public relative to the margins on loan collateral finances—to experience the strongest (we note in detail in “Appendix 2: Arbitrage growth, supported by strong exports (see And Demand Were The Main Growth Drivers table 1). At the tail, we believe that peripheral For The European CLO Market” that the countries, weighed down by austerity majority of CLO issuance in Europe was programs designed to stabilize budget driven by arbitrage). deficits, as well as relatively high inflation

Table 1 | Main European Economic Indicators By Country Real GDP (% change) Germany France Italy Spain U.K. Eurozone 2009 (4.70) (2.50) (5.10) (3.70) (5.00) (4.00) 2010 3.50 1.50 1.20 (0.10) 1.30 1.70 2011f 3.50 2.00 0.90 0.80 1.50 1.90 2012f 2.50 1.90 1.00 1.50 2.20 1.80 CPI inflation (%) 2009 0.40 0.10 0.80 (0.20) 2.20 0.30 2010 1.10 1.70 1.60 2.00 3.30 1.60 2011f 2.10 2.30 2.50 3.30 4.00 2.30 2012f 2.00 2.00 2.20 1.50 2.90 2.00 Unemployment rate (%) 2009 8.20 9.10 7.80 18.00 7.70 9.50 2010 7.70 9.30 8.40 20.10 7.80 10.00 2011f 7.00 9.00 8.70 21.00 7.70 9.80 2012f 6.50 8.50 8.20 20.00 7.50 9.50 f—Standard & Poor’s forecast. CPI—Consumer Price Index. Source: Standard & Poor’s, Aug. 3, 2011.

64 Leveraged commentary & data february 2012 www.spcapitaliq.com European Leveraged Loans Face Funding Hiatus As CLO Vehicles’ Support Wanes

that further undermines the weak than negative included paper and forest competitive position of industry, at best are products, health care, retail, capital goods, likely to experience minimal, but still positive, consumer products, and chemicals. On growth in real terms. We anticipate that other balance, we still have a somewhat negative countries, such as France and the U.K., will be view for industrial sectors, judging by the in the middle lane. outlook distribution for transportation, Inevitably, corporate performance will hotels and gaming, property, and real largely depend on the macroeconomic estate. The drivers at a high level reflect environment, and the sector and location of the ongoing strength of demand emanating key clients. However, in our view it is from Asia (chemicals, capital goods, high- important to note that most companies in tech), and better-than-expected financial Europe are more operationally leveraged after performance in certain sectors given their the recession, by virtue of the timely and rating levels (including consumer-facing). stringent cost-saving measures enacted However, headwinds persist for sectors during 2009. By the same token, they most exposed to higher commodity prices typically do not have the same degree of with little pricing power (transportation), flexibility to improve liquidity and implement or those exposed to public expenditure further cost-saving measures if a further cuts, as well as companies dependent on unexpected downturn were to materialize in real estate and construction activity the near to medium term. (building materials).

Effects on Standard & Poor’s corporate ratings The default rate is back below the long-term and outlooks average—for now The strengthening in the economic The default rate for speculative-grade environment in 2010 and an improvement in companies has fallen sharply (combining our general business outlook was reflected in both public ratings and private credit both a marked fall in the absolute number of estimates). The 12-month trailing default rating changes across corporate entities, and rate fell to 3.8% at the end of December a switch where upgrades outpaced 2010, from 13.6% at the end of December downgrades for Western European 2009. This equates to 28 companies speculative-grade corporates in first- and defaulting on a total €18.1 billion of second-half (H1 and H2) 2010. This has outstanding debt. The 12-month trailing continued through the first half of 2011. default rate is back below its longer-term Similarly, we have seen a substantial average of 4.0% for the first time since improvement in the distribution of outlooks third-quarter (Q3) 2008. (For more we assign for most industrial sectors in information, see “ Western Europe’s Western Europe. As of July 2011, sectors Speculative-Grade Default Rate Falls Back where more rated companies are on Below Its Long-Term Average—For Now,” positive outlook (or CreditWatch status) published May 3, 2011.)

Chart 5 | EU30 High-Yield Ratings And Credit Estimates

Upgradesand downgrades (2004–2010) Downgrades as%oftotal portfolio Upgrades as%oftotal portfolio

(%) 25

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0 H104 H204 H105 H205 H106 H206 H107 H207 H108 H208 H109 H209 H110 H210 © Standard&Poor’s 2012.

A Guide To The European Loan Market february 2012 65 www.spcapitaliq.com The default rate appears to be running at As a consequence, we are of the view that similar levels in H1 2011, and has benefited defaults could start to pick up again from from the temporary improvement in debt Q1 2012, due to the challenges of market liquidity in recent months, the low refinancing many of the 2006–2008 vintage level of interest rates, and the bulk of loan LBOs. Our current base-case estimation maturities for speculative-grade companies foresees the default rate at the end of 2011 not falling due until 2014–2015. at 3.8%, returning to a higher range of However, we would warn against 5.5%–7.5% by the end of 2012. (For a fuller complacency, as the credit quality of the bulk explanation, see “ Default Rate For of our private credit estimates remains European Speculative-Grade Companies Set relatively weak, in our view. Of the total credit To Climb In 2012 As Balance Sheet Issues estimate data set, 45.5% remained at ‘b-’ or Resurface,”published May 3, 2011). below at the end of 2010, compared with 32.2% at the end of December 2009. In particular, we note: Appendix 2: Arbitrage And Demand •• Many highly leveraged companies, includ- Were The Main Growth Drivers For ing a high percentage that have been The European CLO Market restructured during 2009–2010, Growth from 2001–2007 continue to have weak balance sheets, A hallmark of the 2001–2007 period was despite some recent improvement in the growth of the European CLO market. operational performance. Traditional arbitrage CLO structures •• We anticipate that certain balance- dominated much of the European CLO sheet-constrained LBOs’ ability to landscape throughout this period, where recover will be limited by their lack of increases in issuance volumes year-on- liquidity either to invest in growth capital year were complemented with larger CLO expenditure sufficiently, or to support structures. We note that the average rated higher working-capital requirements issuance amount of a European cash flow that may be needed to grow the business, CLO closing in 2004 was €360.84 million including funding higher inventory levels. (the minimum amount being €262.75 •• Although the bulk of maturities for the million and the maximum €631.5 million), 2006–2008 vintage LBOs does not peak compared with €479.66 million in 2007 until 2014–2015, we remain concerned (minimum €267 million, maximum €1.3 about lenders’ willingness to amend billion). In terms of count, we rated 17 covenants as they tighten in 2012–2013: cash flow CLOs in 2004 (three of which In our view, there are doubts over their have now redeemed); this compares with willingness (for banks) and ability 23 transactions in 2005 (two of which (for CLOs) to refinance many of have redeemed), 64 in 2006 (two now these companies as the maturity redeemed), and a peak of 71 European horizon approaches. cash flow CLOs closing in 2007.

Chart 6 | Standard & Poor’s Rated CLO Issuance—Number Versus Balance

Based on outstanding CLOs No. of deals (left scale) S&P tranche volume (mil. €) (right scale)

80 40,000 70 35,000 60 30,000 50 25,000 40 20,000 30 15,000 20 10,000 10 5,000 0 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 (Vintage) © Standard&Poor’s 2012.

66 Leveraged commentary & data february 2012 www.spcapitaliq.com European Leveraged Loans Face Funding Hiatus As CLO Vehicles’ Support Wanes

So why the rally? structure—are typically lower than the Key to understanding the unprecedented yield generated from the loans held in the growth of the European CLO market is CLO. As a direct consequence, the asset- understanding the motivations behind liability differential (or arbitrage) that CLO creation. materializes will offer relatively attractive Generally, an originator’s motivation behind returns to an equity CLO investor. structuring and issuing CLOs falls into four •• Capital relief/Regulatory capital: Financial broad categories: institutions are typically the originators of •• Arbitrage: One of the key drivers in the such transactions. As we explain below in CLO markets’ rapid growth, in our view. the context of 2008 European CLO origina- The varying risk-reward profile of a CLO tion, selling assets to a CLO reduces the offers attractive returns to noteholders in amount of regulatory capital required for the CLO’s capital structure, relative to market participants, which in turn puts other debt instruments with similar risk less strain on their balance sheets. profiles. To illustrate, let us consider the •• Risk management: Financial companies viewpoint of a CLO equity noteholder. that frequently provide loans to different Structural features such as tranching businesses may wish to reduce their allow an arbitrage CLO model to fund— exposure to such businesses, and so and gain exposure to—leveraged loans. transfer the exposure to other investors The costs of funding the CLO—predomi- through a CLO. nantly driven by the stated spread on the •• Funding: Some institutions may originate most senior class(es) in the CLO’s capital loans and then securitize them in a CLO, to

Chart 7 | Standard & Poor’s Rated CLO Issuance—Initial Versus Current Amount

Based on outstanding CLOs

Initial amount Current amount

(Bil. ¤) 40 35 30 25 20 15 10 5 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 (Vintage) © Standard&Poor’s 2012.

Chart 8 | Average Liability Spread Of European CLOs

Min spread origin Average Max spread (%) 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 2001 2002 2003 2004 2005 2006 2007 2008 2009 Note: The dataset only includes European CLOs which havemore than one S&P-rated tranche. © Standard&Poor’s 2012.

A Guide To The European Loan Market february 2012 67 www.spcapitaliq.com free up their balance sheets and obtain resulted in a dramatic rise in liability pricing funds again. for European CLOs (see chart 8). In 2008, Although a non-exhaustive list, we believe we rated 33 such transactions (of which the above factors have been central to the eight CLOs have redeemed) totaling €26.8 growth of the European CLO market. Coupled billion, a significantly lower number than in with this, we also believe that investor 2007 (71 transactions). The average rated demand for CLO paper over the market’s issuance volume of an individual 2008 evolution remained consistently strong. A European cash flow CLO was €398.8 million. broadening investor base not only helped aid The trends witnessed in 2008 continued the growth in underlying loan issuance throughout 2009, where issuance volumes of volumes and overall market liquidity, but in European cash flow CLOs declined further. Total turn also resulted in improved CLO rated issuance in 2009 was €3.046 billion, economics, with CLO spreads tightening spread over two European cash flow CLOs (of across the CLO capital structure. A review of which one CLO has already redeemed). the European cash flow CLOs that form our In 2010, we rated five European cash flow European CLO Performance Index shows that CLOs, bringing the total rated issuance to just the average cost of funding a cash flow CLO over €3.96 billion. In our view, the incentive fell on average by 47 basis points (bps), to 53 behind these transactions was primarily for bps by 2006 from 100 bps in 2004. We balance-sheet funding as market consider this a key factor supporting the participants continued to find ways to cope conclusion that CLO demand remained with the distressed financial environment. resilient for some time. Although the motivation behind CLO As we have noted in previous issuance has shifted over the years in line publications, traditional arbitrage CLO with the economic environment (i.e., from issuance stagnated dramatically in 2007, traditional arbitrage to balance-sheet with “financing” or “structure-to-repo” funding), to date our research shows that transactions setting the scene for CLO the overall performance of European CLOs issuance in 2008 (see “ European CLOs we rate—regardless of vintage or 2008 Review–Declining Corporate Credit motivation—is currently showing improved Quality Raises Questions About Future CLO performance trends in several key areas, Performance,” published March 20, 2009). as described below. The motivation behind these transactions, in our view, was that CLOs continued to be an attractive form of funding for financial Appendix 3: European CLOs Have institutions and market participants in Continued Their Upswing To managing their risks throughout the global Kick-Start 2011 financial turmoil. Nevertheless, the reduced Our latest European CLO Performance Index confidence and risk-appetite of investors Report (published monthly; see “ April 2011

Chart 9 | European CLOs—Index Average ‘CCC’ Rated Assets By Cohort

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68 Leveraged commentary & data february 2012 www.spcapitaliq.com European Leveraged Loans Face Funding Hiatus As CLO Vehicles’ Support Wanes

European CLO Performance Index Report: Month-on-month holdings of defaulted assets Improving CLO Performance Indicators Spur have fallen from their 2009 peak Fall In Overcollateralization Test Failures,” All of the CLO cohorts experienced the published on June 27, 2011) highlights that highest percentage holding of defaulted the performance of European CLOs since the assets (i.e., assets from obligors rated ‘CC’, start of 2011 has shown positive signs in key ‘SD’ [selective default], or ‘D’) toward the end areas the index covers. of 2009. Specifically, over the last quarter of 2009, the average percentage of defaulted The index average of ‘CCC’ category rated assets assets held by 2004-vintage transactions appears to be leveling off after its 2010 peak was 5.42%, compared with 5.61% for the We calculate the index average of ‘CCC’ 2005 vintage, 4.70% for the 2006 vintage, category rated assets (“the ‘CCC’ index 4.92% for the 2007 vintage, and 3.72% for average”) by computing the average of all the 2008 vintage (see chart 10). assets rated ‘CCC+’, ‘CCC’, and ‘CCC-’ in However, from 2010 onward, the index each cohort. began a gradual decline for all cohorts, Observations from the index show that the which has continued since the beginning of ‘CCC’ index average for all cohorts appears to 2011. Our latest index report highlights that have peaked during the second quarter of as of April 2011, the percentage of 2010 (see chart 9). However, from January defaulted assets held by all the European 2011 onward, the ‘CCC’ index average has CLO cohorts were less than half their values continued decline for all CLO cohorts, with 12 months earlier. The 2008-vintage CLOs the 2005-vintage transactions exhibiting the experienced the largest 12-month decline, largest decline in ‘CCC’ rated holdings where defaulted holdings in 2008-vintage compared with their peak values in 2010 CLO portfolios decreased to 0.43% of total (12.33% in June 2010, versus 7.74% as of assets in April 2011, versus 3.31% in April April 2011). 2010. This is followed by the 2005 cohort As noted in “Standard & Poor’s perspective (to 1.68% from 4.20%), 2006 (to 1.08% on corporate credit quality” in Appendix 1, the from 3.39%), and then the 2007 cohort (to strengthening of the economic environment 0.91% from 2.96%). throughout 2010, coupled with an We believe that the fall in default improvement in our general business outlook holdings in European CLOs has largely been for corporates, has resulted in positive rating due to an increase in corporate changes for speculative-grade corporate restructurings that have been completed entities. Observations from our CLO index where the underlying credit has been show that European CLOs have naturally felt upgraded throughout 2010, rather than CLO the effects of these changes, to the extent managers selling such loans out of their that their portfolios held such loans. portfolios (for more details, see “ Western

Chart 10 | European CLOs—Index Average Defaulted Assets By Cohort

2004 2005 2006 2007 2008 (%) 7 6 5 4 3 2 1 0

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A Guide To The European Loan Market february 2012 69 www.spcapitaliq.com Europe’s Speculative-Grade Default Rate meant that a default or selective default under Falls Back Below Its Long-Term Average–For our criteria was quite often of short duration. Now,” published May 3, 2011). These factors played directly into the reduction In our view, the stronger recovery in 2010, in the percentage of defaulted loans held by coupled with the rising stock market and CLOs to the extent that such loans were held in improving business confidence, was conducive CLO portfolios. to a more lender-friendly environment. This helped to lower the default rate in two ways. Improvements in credit quality and cash flow Firstly, where loans still had four or five years diversion mechanisms have had positive to run to maturity, senior lenders felt implications for OC ratio test cushions comfortable amending covenants and Senior overcollateralization (OC) ratio test resetting spread margins rather than imposing cushions—the difference between the a more contentious restructuring. Secondly, weighted-average OC percentage of senior where restructuring was unavoidable, senior tranches and the weighted-average required lenders were better protected from loss and OC percentage of senior tranches calculated better able to force through a balance sheet by the index—have improved significantly restructuring as quickly as possible to protect over the past 12 months (see chart 11). the commercial prospects of the business. This Observing how senior OC cushions have

Chart 11 | European CLOs—Senior OC Cushions By Cohort

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Chart 12 | European CLOs—Subordinate OC Cushions By Cohort

2004 2005 2006 2007 2008 (%) 6 5 4 3 2 1 0 (1) (2) (3)

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OC—Overcollateralization. © Standard&Poor’s 2012.

70 Leveraged commentary & data february 2012 www.spcapitaliq.com European Leveraged Loans Face Funding Hiatus As CLO Vehicles’ Support Wanes

performed over the past three years shows portfolio notional at the end of 2010), with a that existing European CLOs issued in 2007 further 22 Standard & Poor’s-rated existing have, on average, built the largest senior OC CLOs due to exit their reinvestment periods cushion, with the average senior OC cushion by the end of 2011 (equivalent to €10.65 being 13.29%, and the median senior OC billion CLOs by par amount). cushion 11.77%. Likewise, subordinate OC cushions— CLOs curing their coverage tests defined as the difference between the Senior liabilities in CLO structures have weighted-average OC percentage of deleveraged in an attempt to cure failing subordinated tranches and the weighted- coverage tests. This has resulted in a average required OC percentage of reduction in the amounts of senior liabilities, subordinated tranches calculated by the and a subsequent fall in the denominator index—have also followed suit (see chart value of senior par coverage test calculations. 12). In particular, 2005-vintage European As a direct consequence, the number of CLOs have built the greatest margin in their transactions failing their senior OC ratios has junior OC tests. According to data from our reduced significantly. In January 2011, only CLO index, the average junior OC test cushion six European CLO transactions that form the was 1.03% over the past three years, with a European CLO Performance Index cohort median value of minus 0.03%. 2004-2008 were failing their senior OC ratios, The improvements in OC test ratios for compared with 18 transactions in February European CLOs, in our view, are primarily the 2010, and 21 transactions in December result of transaction seasoning as CLOs exit 2009. As of April 2011, only four CLOs their reinvestment periods, improvements in covered by the European CLO Index are failing senior OC test cushions through their senior OC tests. deleveraging, and improvements in the underlying credit quality of CLO portfolios Reduction in ‘CCC’ category rated assets (particularly regarding the fall in ‘CCC’ and ‘D’ The decline in a CLO’s exposure to ‘CCC’ category rated assets). category rated assets has caused a fall in those assets that are carried at discounted CLOs exiting their reinvestment periods values (above a predefined threshold) in the As CLOs begin to exit their reinvestment calculation of OC ratios (see chart 9). (For a periods, they enter a phase of amortization detailed description, see “ European CLOs where noteholders are repaid principal in 2008 Review–Declining Corporate Credit order of priority as governed by their Quality Raises Questions About Future CLO transaction documents. At the end of 2010, Performance,” published on March 20, 2009). 54 European cash flow CLOs that form our Above all, in our view the reductions in study are now in their amortization periods ‘CCC’ and ‘D’ category rated assets have been (which accounts for €15.5 billion of CLO the most significant factors in improving OC

Chart 13 | European CLOs—Redemption Of CLO Notes By Cohort (%)

Based on outstanding CLOs Initial amount Redemption amount

(%) 100 90 80 70 60 50 40 30 20 10 0 2001 2002 2003 2004 2005 2006 2007 2008 (Cohort) © Standard&Poor’s 2012.

A Guide To The European Loan Market february 2012 71 www.spcapitaliq.com Chart 14 | 2004 European CLOs—Senior OC Cushion Versus S&P Index Averages

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Chart 15 | 2005 European CLOs—Senior OC Cushion Versus S&P Index Averages

2005 senior OC cushion 2005 ‘D’ indexaverage 2005 ‘CCC’ indexaverage (%) 18 16 14 12 10 8 6 4 2 0

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Chart 16 | 2006 European CLOs—Senior OC Cushion Versus S&P Index Averages

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72 Leveraged commentary & data february 2012 www.spcapitaliq.com European Leveraged Loans Face Funding Hiatus As CLO Vehicles’ Support Wanes

Chart 17 | 2007 European CLOs—Senior OC Cushion Versus S&P Index Averages

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Chart 18 | 2008 European CLOs—Senior OC Cushion Versus S&P Index Averages

2008 senior OC cushion 2008 ‘D’ indexaverage 2008 ‘CCC’ indexaverage (%) 18 16 14 12 10 8 6 4 2 0

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Chart 19 | 2004 Vintage European CLO Transactions: ‘CCC’ Rated Assets

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© Standard&Poor’s 2012.

A Guide To The European Loan Market february 2012 73 www.spcapitaliq.com Chart 20 | 2005 Vintage European CLO Transactions: ‘CCC’ Rated Assets

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© Standard&Poor’s 2012.

Chart 21 | 2006 Vintage European CLO Transactions: ‘CCC’ Rated Assets

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Chart 22 | 2007 Vintage European CLO Transactions: ‘CCC’ Rated Assets

Minimum Indexaverage Maximum (%) 30

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© Standard&Poor’s 2012.

74 Leveraged commentary & data february 2012 www.spcapitaliq.com European Leveraged Loans Face Funding Hiatus As CLO Vehicles’ Support Wanes

Chart 23 | 2008 Vintage European CLO Transactions: ‘CCC’ Rated Assets

Minimum Indexaverage Maximum (%) 35 30 25 20 15 10 5 0

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© Standard&Poor’s 2012.

Chart 24 | 2004 Vintage European CLO Transactions: Defaulted Assets

Minimum Indexaverage Maximum (%) 9 8 7 6 5 4 3 2 1 0

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© Standard&Poor’s 2012.

Chart 25 | 2005 Vintage European CLO Transactions: Defaulted Assets

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© Standard&Poor’s 2012.

A Guide To The European Loan Market february 2012 75 www.spcapitaliq.com Chart 26 | 2006 Vintage European CLO Transactions: Defaulted Assets

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© Standard&Poor’s 2012.

Chart 27 | 2007 Vintage European CLO Transactions: Defaulted Assets

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Chart 28 | 2008 Vintage European CLO Transactions: Defaulted Assets

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© Standard&Poor’s 2012.

76 Leveraged commentary & data february 2012 www.spcapitaliq.com European Leveraged Loans Face Funding Hiatus As CLO Vehicles’ Support Wanes

ratios for European CLO transactions over the senior OC cushions experienced gradual past three years. One way to consider the improvements as the index average of ‘CCC’ degree of this relationship is by considering and ‘D’ category rated assets fell. the senior OC test cushions of each cohort against its respective ‘CCC’ and ‘D’ index Asset performance in CLOs average. For all cohorts, we document a Asset performance data as of April 30, strong inverse relationship between these 2011—taken from the latest version of the variables over the past three years, where European CLO Performance Index report.

Table 2 | 2004 Vintage European CLO Transactions: Par Coverage Tests May June July Aug. Sept. Oct. Nov. Dec. Jan. Feb. March April Reporting month 2010 2010 2010 2010 2010 2010 2010 2010 2011 2011 2011 2011 Deals failing senior 1 0 0 0 0 0 0 0 0 0 0 0 OC tests Deals failing 6 6 7 8 8 8 6 6 4 3 4 1 subordinate OC tests (% of senior tranches) WA OC 123.30 123.03 124.13 124.33 124.81 125.96 126.73 126.93 127.9 128.76 129.21 131.64 WA required OC 117.92 117.80 118.05 118.06 118.05 118.09 118.09 118.05 118.06 118.08 118.07 118.17 (% of subordinate tranches) WA OC 100.65 100.72 101.67 101.79 102.24 102.74 103.23 103.38 103.8 103.99 104.2 104.77 WA required OC 103.52 103.55 103.59 103.57 103.58 103.58 103.56 103.58 103.57 103.57 103.55 103.54 OC—Overcollateralization. WA—Weighted-average.

Table 3 | 2005 Vintage European CLO Transactions: Par Coverage Tests May June July Aug. Sept. Oct. Nov. Dec. Jan. Feb. March April Reporting month 2010 2010 2010 2010 2010 2010 2010 2010 2011 2011 2011 2011 Deals failing sr. 1 1 1 1 1 0 1 0 0 0 0 0 OC tests Deals failing sub. 8 6 5 6 5 4 2 4 3 2 3 2 OC tests (% of senior tranches) WA OC 124 123.89 125.14 125.51 125.77 126.24 126.24 126.63 127.35 128.48 128.63 128.92 WA required OC 116.22 116.24 116.55 116.52 116.56 116.57 116.16 116.59 116.64 116.64 116.61 116.62 (% of subordinate tranches) WA OC 101.73 101.82 102.93 103.03 103.19 103.52 103.48 103.68 103.97 104.31 104.61 104.62 WA required OC 103.51 103.5 103.66 103.67 103.67 103.69 103.51 103.7 103.71 103.7 103.7 103.72 OC—Overcollateralization. WA—Weighted-average.

Table 4 | 2006 Vintage European CLO Transactions: Par Coverage Tests May June July Aug. Sept. Oct. Nov. Dec. Jan. Feb. March April Reporting month 2010 2010 2010 2010 2010 2010 2010 2010 2011 2011 2011 2011 Deals failing sr. 4 5 7 5 3 4 2 2 0 0 0 0 OC tests Deals failing sub. 27 30 30 26 22 20 20 18 16 14 11 11 OC tests (% of senior tranches) WA OC 129.89 129.69 130.15 130.20 130.62 131.31 131.21 131.64 132.19 132.89 133.04 133.11 WA required OC 119.65 119.49 119.70 119.77 117.35 119.83 119.75 119.84 119.88 120.04 119.92 119.78 (% of subordinate tranches) WA OC 102.80 102.95 103.19 103.40 103.63 103.88 103.98 104.14 104.55 104.89 105.21 105.36 WA required OC 104.21 104.18 104.20 104.21 104.20 104.21 104.21 104.20 104.20 104.20 104.19 104.20 OC—Overcollateralization. WA—Weighted-average.

A Guide To The European Loan Market february 2012 77 www.spcapitaliq.com Appendix 4: Industry And Country industry codes in our CDO Evaluator credit Concentrations In European CLOs model. Considering CLOs’ underlying portfolios at the end of 2010, the underlying In our data set, we analyzed the potential loans in our data set were just over 12% systemic maturity risk through industry concentrated in the business equipment and sector concentrations, as defined by the

Table 5 | 2007 Vintage European CLO Transactions: Par Coverage Tests May June July Aug. Sept. Oct. Nov. Dec. Jan. Feb. March April Reporting month 2010 2010 2010 2010 2010 2010 2010 2010 2011 2011 2011 2011 Deals failing sr. 6 7 7 6 5 7 7 6 5 4 3 2 OC tests Deals failing sub. 31 34 33 32 30 26 26 27 22 20 17 16 OC tests (% of senior tranches) WA OC 133.23 133.21 134.12 133.91 134.41 134.31 134.98 134.12 134.78 135.20 136.84 137.11 WA required OC 122.91 123.04 123.08 122.87 123.07 122.72 122.94 122.67 122.73 122.73 123.16 123.12 (% of subordinate tranches) WA OC 102.29 102.24 102.48 102.77 102.94 103.10 103.35 103.54 104.02 104.33 104.71 104.85 WA required OC 104.06 104.10 104.07 104.08 104.09 104.22 104.18 104.07 104.11 104.11 104.08 104.11 OC—Overcollateralization. WA—Weighted-average.

Table 6 | 2008 Vintage European CLO Transactions: Par Coverage Tests May June July Aug. Sept. Oct. Nov. Dec. Jan. Feb. March April Reporting month 2010 2010 2010 2010 2010 2010 2010 2010 2011 2011 2011 2011 Deals failing sr. 4 3 3 4 2 2 2 2 1 2 2 2 OC tests Deals failing sub. 4 5 4 4 4 4 3 4 2 2 2 2 OC tests (% of senior tranches) WA OC 136.89 137.25 136.86 135.65 138.40 139.65 140.40 140.10 140.39 141.66 142.81 143.50 WA required OC 126.37 126.35 126.42 126.56 125.48 127.14 126.87 126.89 125.83 126.87 126.86 126.93 (% of subordinate tranches) WA OC 108.34 107.53 107.86 108.45 108.67 108.82 110.02 108.65 108.30 109.75 110.02 110.34 WA required OC 108.77 108.85 108.84 108.85 108.86 108.85 109.91 108.85 108.57 108.90 108.90 108.93 OC—Overcollateralization. WA—Weighted-average.

Table 7 | European CLO Portfolio—Maturity Profiles Based On The Top 10 Industries At the end of 2010 Aggregate Dominant year Exposure Industry exposure (bil. €) of maturity (%) Business equipment and services 10.27 2015 12.06 Health care 7.69 2015 9.03 Cable and satellite television 6.98 2014 8.19 Publishing 5.14 2015 6.04 Telecommunications 4.30 2014 5.04 Retailers (except food and drug) 4.19 2015 4.92 Leisure goods/activities/movies 3.90 2015 4.58 Chemicals and plastics 3.49 2014 4.09 Radio and television 3.48 2015 4.08 Food service 3.22 2015 3.78

78 Leveraged commentary & data february 2012 www.spcapitaliq.com European Leveraged Loans Face Funding Hiatus As CLO Vehicles’ Support Wanes

Table 8 | European CLO Portfolio—Industry Breakdown 2008–2010 Industry (%) 2008 2009 2010 Business equipment and services 10.23 11.13 12.06 Health care 8.15 8.62 9.03 Cable and satellite television 8.06 9.27 8.19 Publishing 6.82 6.72 6.04 Telecommunications 4.82 5.64 5.04 Retailers (except food and drug) 4.37 4.30 4.92 Leisure goods/activities/movies 4.61 4.39 4.58 Chemicals and plastics 6.37 5.47 4.09 Food service 3.29 N/A 3.78 Building and development* 3.95 3.82 N/A *In 2010, building and development accounted for 3.45% and was the 12th-largest industry exposure. N/A—Not applicable.

Table 9 | European CLO Portfolio—Geographical Breakdown 2008–2010 Country (%) 2008 2009 2010 U.K. 20.74 19.50 19.57 France 17.40 16.09 16.90 Germany 16.68 16.92 16.10 The Netherlands 9.45 11.10 11.13 U.S. 10.36 10.44 10.41 Spain 5.93 6.18 6.14 Denmark 4.21 4.72 4.51 Sweden 4.14 3.90 4.37 Italy 3.44 3.53 2.95

Ireland 2.93 2.70 2.83

Table 10 | E uropean CLO Portfolio Maturity Breakdown Based On The Top Five Countries At the end of 2008 —Breakdown of each country's total (%)— The Year of maturity U.K. France Germany U.S. Netherlands Total portfolio amount (bil. €) 17.42 14.62 14.01 8.7 7.94

2009 0.12 0.02 0.34 0.36 0.00 2010 0.31 0.13 0.23 0.56 0.04 2011 5.90 0.18 3.31 1.46 0.28 2012 10.51 1.65 7.23 13.69 1.40 2013 19.46 12.11 15.09 21.43 19.87 2014 25.26 25.24 24.36 42.52 40.32 2015 22.13 33.04 29.20 14.59 22.58 2016 10.53 23.75 16.04 1.36 10.91 2017 3.94 3.04 3.21 3.20 4.14 2018 1.02 0.64 0.89 0.25 0.10 2019 0.00 0.00 0.00 0.05 0.00 2020+ 0.83 0.19 0.09 0.54 0.35

A Guide To The European Loan Market february 2012 79 www.spcapitaliq.com services industry, and the majority of these obligors identified in the health care industry loans are set to mature at the beginning of accounted for just over 9% of the assets that 2015. That is, 23.4% of all loans—equivalent collateralize European CLOs. In terms of the to €2.4 billion of the loans in the business amount of debt falling due, €2.58 billion—or equipment and services industry—are set to 33.6% of these obligors—is set to mature mature in 2015. Before then, €2.33 billion of also in 2015. loans in this sector are set to mature In terms of geographical breakdown throughout 2014. (again, as defined by the country codes in our The second-largest concentration was in CDO Evaluator credit model) in all years from the health care industry. In total, corporate 2008 to 2010 the U.K. bares the most

Table 11 | E uropean CLO Portfolio Maturity Breakdown Based On The Top Five Countries At the end of 2009

—Breakdown of each country's total (%)— The Year of maturity U.K. France Germany Netherlands U.S. Total portfolio amount (bil. €) 16.80 14.57 13.86 9.56 8.99 2010 0.06 0.10 0.00 0.03 0.00 2011 0.68 0.27 0.15 2.32 0.71 2012 4.76 3.51 0.08 0.95 4.06 2013 9.06 7.34 1.50 2.88 9.45 2014 17.28 17.54 10.34 16.96 19.92 2015 26.71 22.64 26.81 24.13 44.64 2016 23.62 29.17 33.14 22.73 13.39 2017 10.88 14.34 23.46 19.53 3.31 2018 4.34 3.77 3.44 10.15 3.41 2019 1.28 1.05 0.66 0.12 0.27 2020+ 1.33 0.28 0.41 0.20 0.83 2020+ 0.83 0.19 0.09 0.54 0.35

Table 12 | E uropean CLO Portfolio Maturity Breakdown Based On The Top Five Countries At the end of 2010

—Breakdown of each country's total (%)— The Year of maturity U.K. France Germany Netherlands U.S. Total portfolio amount (bil. €) 16.20 13.99 13.33 9.21 8.62

2011 1.96 0.04 1.08 1.50 4.70 2012 4.10 1.24 4.01 2.75 4.41 2013 18.83 11.20 8.13 14.24 13.70 2014 24.33 24.68 28.98 22.14 37.12 2015 25.70 30.77 33.83 20.72 21.08 2016 13.65 24.23 18.51 22.04 12.68 2017 8.64 6.20 3.56 14.04 4.89 2018 1.21 0.82 1.55 0.28 0.26 2019 0.05 0.09 0.16 1.43 0.27 2020+ 1.52 0.73 0.19 0.86 0.89 2020+ 1.33 0.28 0.41 0.20 0.83 2020+ 0.83 0.19 0.09 0.54 0.35

80 Leveraged commentary & data february 2012 www.spcapitaliq.com European Leveraged Loans Face Funding Hiatus As CLO Vehicles’ Support Wanes

significant concentration of loan maturities •• European CLOs 2008 Review—Declining in European CLO portfolios. As of 2010, for Corporate Credit Quality Raises Questions instance, U.K. borrowers represented nearly About Future CLO Performance, March 20, 20% of loan maturities in CLOs. This is 2009 followed by France and Germany, which in •• The Use Of Rating-Based Haircuts In Event total represented over 30% of loan maturities Of Default Overcollateralization Tests For held by CLOs at the end of 2010. CDOs, March 19, 2008 Studying the loan maturity profile of each •• An Introduction To CDOs And Standard & country indicates that all three economies Poor’s Global CDO Ratings, June 8, 2007 (the U.K., France, and Germany) face the bulk •• Structured Finance Glossary Of of maturing loans from domestic borrowers Securitization Terms 2007, June 11, 2007 in 2015. Just over one-quarter of U.K. •• Global Cash Flow And Synthetic Criteria, borrowers are scheduled to repay their loans March 21, 2002 in 2015, compared with 30.77% for France •• European CLO Performance Index Report, and 33.83% for Germany (see table 12). l published monthly Related articles are available on RatingsDirect. Criteria, presales, servicer Related Criteria And Research evaluations, and ratings information can also •• April 2011 European CLO Performance be found on Standard & Poor’s Web site at Index Report: Improving CLO Performance www.standardandpoors.com. Alternatively, Indicators Spur Fall In Overcollateralization call one of the following Standard & Poor’s Test Failures, June 27, 2011 numbers: Client Support Europe (44) •• Western Europe’s Speculative-Grade 20-7176-7176; London Press Office (44) Default Rate Falls Back Below Its Long- 20-7176-3605; Paris (33) 1-4420-6708; Term Average—For Now, May 3, 2011 Frankfurt (49) 69-33-999-225; Stockholm •• Update To Global Methodologies And (46) 8-440-5914; or Moscow (7) Assumptions For Corporate Cash Flow And 495-783-4011. Synthetic CDOs, Sept. 17, 2009

A Guide To The European Loan Market february 2012 81 www.spcapitaliq.com Key Contacts

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