IFR Leveraged finance 2007

Leveraged finance has been the buzzword in Asian financial circles for the best part the past five years with China and India considered critical for the financing activity’s growth in Asia. That dependence has increased further as traditionally strong LBO markets such as South Korea and Taiwan have slowed down, leaving Australia as the region's most active LBO market.China’s LBO activity has sputtered in stops and starts, while India’s has been more consistent and steady largely because LBOs have taken place in outbound M&A deals. It is easier to structure financings supporting Indian companies when they are acquiring assets overseas rather than financings for foreign companies buying Indian assets. To date there has been only one inbound LBO in India – the US$368m LBO for Software Development Systems (SDS) in September 2006 – dispelling doubts that the country's regulatory regime was unsuitable for LBOs. The deal's simple yet clever structure got around the regulations relating to dividend repatriation.Since then there have been no LBOs involving foreign companies acquiring Indian assets largely because there have hardly been any inbound acquisitions. On the other hand, hardly a week goes by without an Indian company getting involved in an overseas acquisition, which has given rise to a steady flow of LBO financings. Half a decade ago nobody would have imagined that India would be among the top three loan markets in Asia (ex-Japan, ex-Australasia) by volume. But that all changed in 2006 when almost US$30bn of loans were booked in India, mostly foreign currency loans, with a good portion of that coming through M&A financings. Not only have top-tier companies been in the limelight, but also second and mid-tier businesses too, highlighting how much things have changed.“The SDS deal set the ball rolling for LBO activity from India with Tata Steel following in its footsteps a couple of months later. Tata Steel had the size and profile going for it and has created the platform for other deals to follow suit,” said one banker in Hong Kong. Tata Steel’s transaction, featuring recourse and non-recourse debt, has truly been a landmark deal in many respects with the structure being replicated in subsequent financings. The financing enabled Tata Steel take over the UK's Corus Steel for nearly £6bn (US$11.76bn) in what was a transformational acquisition. The financing was big, well-structured and paved the way for other acquisition financings to take the LBO route. Tata Tea’s US$677m acquisition of a 30% stake in US-based Energy Brands followed soon after and was financed through £284.3m four-tranche loan and a £269m non-recourse PIK loan. The most recent deal is the US$5.2bn dual-tranche loan for Hindalco Industries that will fund the company’s US$6bn acquisition of Canada’s Novelis. The deal features a US$2.8bn recourse tranche – the largest for an Indian company – and a US$2.4bn non-recourse tranche. Second and mid-tier Indian corporates have also jumped on to the bandwagon proving that LBOs need not just be the preserve of the top-tier names. The best example is Havell’s India, a lighting and electrical equipment manufacturer, which has acquired European lighting systems company SLI Sylvania for €227.5m. Havell’s, which has a market capitalisation of US$547m, is tapping a €210m recourse and non-recourse financing that will launch shortly and provide a good test of lenders’ appetite for mid-tier Indian credits.Also launching soon is a £635m recourse and non-recourse financing for United Breweries Group, which will finance its acquisition of Scottish spirits maker Whyte & Mackay for as much as £550m. Tata Power’s US$1.6bn acquisition of a 30% stake in Indonesian coalminer Bumi Resources could potentially see another M&A financing, but given the non-controlling stake Tata Power is getting, the chances of an LBO are pretty slim. Outbound acquisitions are providing the bulk of LBO activity and this is likely to remain the case as Indian c

China has long been a hotbed for mergers and acquisitions and with ample opportunities to book high-yielding assets, international lenders have been quick to establish leveraged financing teams in a bid to get a share of the Chinese LBO pie. Interest in Chinese LBOs seems to exceed their success, however, as so far only one deal – GUM Holdings' US$181m five-year LBO financing – has succeeded in syndication.The real challenge in getting GUM’s LBO away was the market’s perception of regulations in China such as the ability to pledge the shares and assets of the target company as security for the financing. The leads on GUM’s financing attempted to secure a share pledge, but could not do so because they could not track down all the minority shareholders required to get 100% shareholder approval for the pledge – one of the requirements in China for a debt secured by a share pledge.Although not every invited got internal approval, it nonetheless provided a significant opportunity to establish what the pressure points are for lenders weighing up Chinese LBOs and was a small but vital step in the sector's development.The result brought out the differences between lending practices in Asia and those in developed markets. In Europe and US, LBOs are essentially seen as cash flow lending with the financing structure only adding another layer of comfort to lenders. Asian lenders, by contrast, are typically brought up on a diet of asset-based lending.If sometimes it is the security on LBOs that is the issue, other times it is the government that is the road block. Carlyle Group’s US$375m acquisition of an 85% stake in China's largest construction machinery maker, Xugong Construction Machinery, in October 2005, is the best example of the government acting as the blocker instead of a facilitator. Carlyle was forced after a 2-1/2-year wait to revise its stake to 45% but is still awaiting approval. Xugong’s LBO refinanced a bridge loan and featured an offshore holding company as the borrower. The deal also featured security in the form of a pledge over 85% of the shares of the holding company, which could not be enforced for three years as per a shareholders’ agreement between Carlyle and the remaining holding company shareholders.Many believe Carlyle’s failure to bag the asset was largely due to the government’s unwillingness to allow foreigners to acquire strategic assets. Further proof that Chinese regulations were not conducive to LBOs came in March 2006 when the US$282m five-year LBO for Harbin Pharmaceutical Group Holding, which came close to becoming the country's first syndicated LBO financing, was cancelled because of a sudden change in regulations.Some, however, believe that LBOs can still be done in China and that deal flow will become more regular in time. “Foreign buyers acquiring Indian companies face similar regulatory hurdles as in China, thus killing many possibilities of classic LBO financings as well. However, the Flextronics deal in India got a blowout response from the market,” said one loan banker.Indeed, the US$368m seven-year deal backing KKR's US$900m buyout of Software Development Systems in September 2006 is the only true Indian LBO. Key to its success was the clever structure that ensures the repatriation of cash flows to Cayman Islands-incorporated SDS so that it could service the debt being raised partially to fund the acquisition.In contrast, China's latest and largest ever LBO – a US$430m 5-1/2-year LBO that backs 3Com Technologies' purchase of a 49% stake in Huawei-3Com Technologies – continues to flounder. After receiving only two commitments since its January launch, the deal was flexed in early April after lender concerns about the sector, a 18-month non-compete agreement with stronger partner Huawei and the company's business model without the latter’s involvement. Another deal that failed in syndication was Asia Timber Products' US$86m LBO loan on which the two leads ended up holding US$76m – 88.4% of the

Australia and New Zealand have witnessed a flowering in demand for leveraged financing amid unprecedented levels of private equity activity that has sought to return some of the region's best-known listed companies back into private hands.The proposed A$11.1bn sale to private equity firms of national carrier Qantas Airways has prompted heated debate in Australia. The next iconic Australian brand up for grabs is retailer Coles. Final plans are being formulated by Coles management for the sale of the group, either in its entirety, or with separate sales for the individual businesses.Meanwhile, New Zealand's largest ever leveraged buyout, the NZ$2.2bn sale by Telecoms of its Yellow Pages directories business, has produced a winner in the form of a consortium comprising CCMP and Ontario Teachers Pension Plan. ABN AMRO, Barclays Capital, Calyon and Deutsche Bank provided the financing which consisted of NZ$1.2bn in six-year senior debt and another NZ$300m six-and-a-half year subordinated tranche.Leverage is expected to be more than 9x total net debt-to-Ebidta, which would make the deal the most highly geared LBO transaction seen in Australasia so far. It also set a new benchmark for Yellow Pages deals globally. Although LBOs from the region have only recently taken off in terms of size, frequency and public awareness, these types of transactions first started appearing around a decade ago."The market has been active and growing since the late 1990s, although mostly in the small to mid-sized space with the exception of the occasional larger type deal once every 12 to 18 months," said David Chapman, director of corporate & structured finance at BOS International."However, most of these transactions up to the last 12 to 18 months occurred through the sale of public company "non-core" divisions or private sales," he said. Chapman defines small to mid-sized deals those with financings of up to A$750m. What has changed has been the amount of cash controlled by global private equity funds, which have started to unearth assets in previously overlooked markets with which to maximise investment returns."Over the last few years the number of private equity/leveraged buyout deals in Australia has been steadily increasing, and with the weight of liquidity in the private equity space globally and high levels of activity in Europe and the US, it was inevitable that the trend would follow in Asia-Pacific," said Graham McNamara, global head of syndications & agency at nabCapital."Australian companies are by and large well managed, conservatively geared and often operate as part of duopolies or small oligopolies," said Aziz Dean, managing director, fixed-income capital markets at Citigroup. "Add to that the stable economy and legal and regulatory frameworks and it should come as no surprise that leading private equity firms are finding this a good market to invest in." The arrival in Australasia of the likes of legendary buyout firm KKR has coincided with a sharp increase in the percentage of mergers and acquisitions attributable to private equity and their efforts to return public companies back into private ownership."M&A has not materially increased, but critically it is the percentage of M&A which is going to private equity which has increased substantially from around 5%-8% a few years ago to circa 23% for year-to-date 2007," said BOS International's Chapman.Larger deal sizes have forced innovation as funding requirements begin to exceed the ability of the local industry to provide capital without help. Before retailer Coles rejected an A$18.2.bn offer from a consortium led by KKR last year (Coles management is preparing a new sale process in which KKR is expected to take part) much speculation had been focused around how lead arrangers would source funds from overseas – with troublesome foreign exchange issues – without making the whole process prohibitively expensive."The structure and terms of local financings are quickly catching up to Eur

The market in Central and Eastern Europe reached a milestone earlier this year with the completion of the debt supporting the Falcon Consortium's buyout of two telecom assets in the Czech Republic. Backed by a debt package of €770m, the loan closed well oversubscribed resulting in a structural and pricing flex. This success showed that sponsors can achieve similar terms in central Europe to what they can achieve in the more mature western European markets."It is hard to generalise given the diversity of the countries within the central and Eastern European region," said Paul McKenna, managing director and head of leverage finance at ING. "However, for EU accession borrowers the extent of structural aggression in terms of purchase price and debt multiples is now fairly close to Western Europe."The Falcon Consortium's success was quickly followed by Permira's buyout of Hungarian chemical group, BorsodChem. Backed by a €1.15bn loan package, the deal set a regional LBO debt record and both structure and pricing were flexed down.Despite these successes, however, volumes remain small, with just US$1.79bn worth of deals completed in 2006, according to Thomson Financial. In addition, though from a private equity perspective there are higher returns available in countries like Bulgaria, Romania and Ukraine, large buyout funds remain focused in the first wave of EU accession countries. Since their accession to the EU, the countries of central and eastern European have all performed economically extremely well. For buyout funds this means the region offers superior growth prospects, but this is leading to higher purchase prices and higher debt multiples.And while the loan markets has shown maturity in terms of back-ended structures and reverse flex, the universe of lenders - specifically institutional investors - is limited. This has put the loan market at something of a disadvantage to the bond market where investors have been willing to accept higher leverage multiples. For example, BITE, a Baltic mobile group, recently completed a €300m FRN bond sale supporting its Mid Europa-led buyout with leverage mooted to be close to 10x.The relative sophistication of the bond market means the loan market is not automatically a sponsors' first port of call so the outcome of the auction of the Bulgarian telecommunications BTC is set to be closely watched. A 65% stake in the group is up for sale and, not withstanding trade interest from groups such as Turkcell, a private equity solution is a good possibility. So far several sponsors are rumoured to be looking at the group including Mid Europa, Texas Pacific Group and Warburg Pincus and bankers said that if private equity was victorious, then the deal could come with a debt package of at least a €1bn - a big ticket for any Bulgarian borrower, let alone a buyout.Although, BTC could be another milestone in the region, deal flow remains light. And while €1bn-plus deals may grab the headlines, the market is still bereft of smaller deals that are the bread and butter of the western markets. This is in part because difficulties remain. Bankers said that performing due diligence was not as easy in the region and that there was not the same confidence in the legal system. Moreover, as a general point, lenders said that financial reporting was not as reliable in the region as it could be, which could partly explain sponsors' preference for established businesses in predictable highly cash generative sectors such as telecoms.As ING's McKenna explained: "As for convergence with Western Europe, with regard to the earlier EU entrants - Poland, Hungary and Czech Republic - convergence has already very nearly happened; whilst for the newer entrants - Romania and Bulgaria - you are probably looking at a three to five-year time horizon. In terms of deal structure, there is little difference with features like aggressive leverage, tight pricing, back ended debt profiles and reverse flex now common in the bigger deals

Lending volumes in the US increased 5.8% in the first quarter of this year compared to the same period last year, according to data from Thomson Financial. In that same period investors have not only experienced more loan volumes, but also novel structures. Clearly the market has become used to the fact that second lien loans are here to stay, despite the absence of any major restructuring event to indicate how lenders would fare in a bankruptcy (the chief concern among second-lien investors). Second lien lending in the first quarter rose 27.4% to US$7.1bn compared to the US$5.6bn last year. Probably the most important recent development in structuring has been the erosion of covenant packages. Aided by low default rates and aggressiveness among sponsors, covenant-light credit agreements – those that contain only incurrence covenants – have increased in volume exponentially. Bankers, lenders and borrowers are mixed on the trend and on what the potential fallout would be should default rates increase. But as the secondary loan market develops and investors become more fluent with loan credit default swaps, it is generally perceived as less risky than before to hold paper that is light on covenants. Investors can trade out of risk more easily than before. That said, covenants act more like an early-warning system than a cure-all for market woes. With most of the financial disasters in the history of the loan market, the loans involved were covenant protected. When defaults begin to increase – and they will – covenants will do little to correct it.These maintenance-only transactions are occurring more frequently and in larger size. Investors recently piled into jumbo deals for Freeport McMoRan and Univision. Univision’s covenant-light US$7bn term loan B pays 225bp over Libor. Freeport’s US$2.5bn term loan A pays 150bp over Libor. Even at those tight spreads investors could not seem to get enough of them. “Almost every deal we’ve looked at this year has been covenant light,” a banker said. “Before it was an exception to the rule, now it’s the rule.”Although covenant-light deals are now being actively employed, bankers expect them to be cyclical. Soon enough investors will be able to gain ground once again and maintenance covenants will begin to creep their way back into credit agreement. Asset-based dealsAsset-based loans are another financing structure that is usually included along side covenant-light loans in buyout financing packages. Asset-based loans are secured by a company’s receivables, inventory, equipment and/or real estate and are often used today in larger deals for retail companies, for instance. Michaels Stores completed a US$400m asset-based revolver late last year as a part of the financing behind the buyout of the company. Bain Capital and the Blackstone Group bought the specialty crafts retailer for about US$6bn. The ABL was part of the US$3.4bn loan that financed the transaction. Among other advantages to asset-based deals – in which borrowing capacity is often based on inventory level – is that it targets another group of investors, this time asset-based lenders. While some of these larger transactions might be able to find full financing in among cash flow-loan investors, the use of ABLs reflects arrangers desire to diversify the investor base – to the benefit of investors and issuers.Taking a PIKAnother financing structure that is providing borrowers with financial flexibility at the expense of lenders is the use of pay-in-kind toggle loans and notes. In a typical PIK credit agreement, usually done at the holding company level, a company can elect to pay its interest expense in cash or with more debt – with obvious implications for lender and borrower. PIK notes have been ideal for sponsors that want to take out a quick dividend following their purchase. Sponsors may not want to tie a potentially cash-strapped portfolio company to strict payment schedule for the purpose of paying a dividend with the possibil

Volatility stemming from the global equity markets, concerns over a looming economic slowdown and uncertainty about the ultimate effects in the US economy of the sub-prime market mortgage and housing market has trickled down to both the high-yield and the loan market. This uncertainty is already affecting LBO-related deals both in the primary and secondary markets. Leveraged investors have necessarily become more disciplined. This sentiment can be seen in the performance of recent high-yield issues in recent LBO transactions. The change in sentiment is evident in the aftermarket as riskier LBOs have seen a less welcoming investor base. Reader's Digest's, for instance, priced a US$600m Caa1/CCC+ offering in February to fund the company's buyout by a group of private equity firms. The new 9.00% notes due 2017 have struggled in secondary, with bids seen at 96.50-97 in late March. Digicel's Caa2-rated two-part offering, also part of a buyout financing, was down a few points from its par new issue price and Rite Aid's new 7.5% notes due 2017, used to fund an acquisition, traded down to 98.25–98.75 in late March. Knock-on effectLooking back a year or two ago, almost any leveraged buyout could get done on aggressive terms. Yet as investors witness several recent buyout financings trade poorly, there is a new sense of discipline in the market place. Strong credits will continue to perform well in the primary market, while weaker ones will have to pay up. Investors are using discretion. The feeling has also trickled to the loan market, despite the seniority of loans and the increased security the asset class offers. Investors push for better terms. Issuers trying to reduce pricing or loosen terms have found it increasingly difficult. This has affected both LBO and non-LBO related deals. Realogy faced considerable challenges when marketing its US$4.7bn bank debt deal. Ply Gem Industries, PETCO, Aramark are recent examples of ambitious repricings and covenant-striping amendment proposals that had to be moderated before getting done. “People are realizing that loans are not risk-free investments,” said investor.The market is certainly not as strong as it was a month ago. “There are people that looked at the market in January and February and were prepared to launch covenant-stripping amendments or repricing amendments that decided not to,” a banker at a top tier investment bank said. “The dialogue from capital markets to the client over the course of the last three days has been more cautious to clients that are doing opportunistic deals,” he said.Such uncertainty has also translated into softer trading levels in the secondary market. The average price in the loan market has been fluctuating between 100.5-100.75 since the beginning of the year, a loan market strategist said. “At the bottom of the China news average bids went to 100.5,” he said. But that doesn’t mean that the loan market is unappealing for issuers or investors. “There’s been pushback and spreads are a little bit wider but, just because spreads go back to more normal ranges and deals have two or three maintenance covenants, secured by liens on all assets, that doesn’t mean the world is coming to an end. It’s just a swing back of the pendulum to the more normal range of deal structure," said Jonathan Insull, portfolio manager at TCW Asset Management.It’s all fundamentalsAn increase in the cost of capital, would indeed have an undermining effect in company’s valuations thus affecting LBO multiples. But so far the increase in the cost of capital has only been in the margin at around 10bp. More than 10bps here and there, a decline in the growth of corporate earnings would actually hamper valuations.“An increase in the cost of capital will have a dampening effect in valuations,” a private equity source said. “But, the biggest dampening effects in valuations are revenue growth, which is driven by GDP, and corporate earnings growth (which is driven by revenue growth and costs or o

In fact, Europe seems poised for a major breakthrough in LCDS. However, there significant obstacles stand in the way of the market's development."Loans are much more esoteric and less standardised than bonds and that has an impact on the LCDS product," said Shane O’Gorman, a loan CDS trader at Credit Suisse in London, explaining that LCDS is a more difficult product to get right than regular CDS. "LCDS in Europe (and initially in the US) is cancellable and references a particular lien of a particular loan." The effect is that a refinancing immediately sees CDS contracts torn up.In 2006 the US derivatives industry manoeuvred around this obstacle by creating standard documentation containing key provisions including a limiting of credit events for the LCDS contracts to bankruptcy and failure to pay. The new contract excludes refinancing as a credit event where a substitute reference obligation is put in place with 30 days of repayment. US LCDS therefore became referenced to any equivalent loan held by the borrower entity, rather than to a specific tranche. That refinement met the desire among investors to hold a contract which is relatively free of the constant ‘orphaning’ concerns that arise because loans can be, and are, repaid at any time.O’Gorman sees Europe moving fairly swiftly in the same direction, albeit without moving entirely to the US model. "Right now it looks like the plan is push on with a compromise whereby cancellable contracts will continue to trade alongside newer contracts with a non-cancellable clause included which has been agreed and approved by the ISDA and all the major players. The new agreed contract should give an immediate lift to liquidity and confidence in the product," he said.As well as impacting liquidity the twin track approach would mean existing LCDS contracts could continue in place unaffected by the change, with market participants able to invest in the contract which best suits their purpose. O’Gorman expects the increase in liquidity to bring new entrants into the market without driving out existing buyers of LCDS. "Bank loan books will continue to buy protection, particularly with Basel II creating a regulatory need to hedge risk, hedge funds and the structured community, notably synthetic CLOs will allocate into the product not least because the loan market's ratio of return to volatility is unrivalled right now," he said. Myles Llewellyn Jones, head of secondary loan trading at ING, agreed that the current situation limited tradability: “Right now, with more sellers than buyers, the yield is from selling. There is a desire to create a more liquid/tradable product." The development of less cancellable contracts will meet some of the concerns of potential investors but the European loan market’s own characteristic privacy is also an issue. While the bond CDS market has grown up referencing publicly traded securities in Europe, there is no obligation on borrowers or lenders to file publicly information on loan contracts, including details of repayments or refinancing. This means information supply is limited to those on the ‘inside’ of any deal. “The problems boil down to the difficulty of referencing a private instrument," said ING's Llewellyn Jones. "In Europe, loan agreement details are not made public in the way they are in the US. If the referenced entity is not quotable and tradable then it becomes extremely difficult to price against volatility.” He points back to the US solution, suggesting it could be possible to trade LCDS without greater disclosure by sponsors and borrowers: “That’s a key reason US-style LCDS is preferable – if the referenced entity is broadened out then there is no need to look as closely at the loan agreement, which gets around the private information issue.”Such a compromise would likely deter some investors, however, who would still face difficulties tracking the various credit facilities of the referenced entities. One potential solution is use the c

The first quarter saw the acceptance of investor flexibility establish itself as a guiding principle in the leveraged loan market. A recent spate of European LBO financings have been launched without an A tranche or have undergone radical structural flexes after syndication. At the same time price flexing, a precursor trend in 2006 to the current round of structural flexing, has become increasingly aggressive and now shows signs of spilling over from the leveraged to investment grade loan market.KION's €3.5bn financing of this year and United Biscuit's £1.45bn facility of late last year were launched without any A tranche. United Biscuits then undertook a structural flex this year in which the C tranche was dropped and the mezzanine and second-lien tranches were reduced, and the amounts rolled into a beefed up B tranche. On TdF's €3.97bn financing, the mezzanine tranche was dropped and spread among the second-lien, B and C tranches. In February BNP Paribas came to market with a waiver request for a major restructuring of the €2.8bn financing put in place in 2006 backing the creation of Numericable - sponsor Cinven's merger of French cable companies Ypso, Altice 1 and Noos. The Numericable deal, successfully closed despite initial investor kickback, was in effect a time delayed structural flex - creating a €800m nine-year term loan C at 275bp over Libor that will replace the €250m nine-year second lien tranche at 475bp and the €500m 10-year mezzanine tranche at 912.5bp. European leveraged debt structures used to be formulaic but over the past 18 months those structures have been fine-tuned to suit particular circumstances. However, the number and regularity of increasingly unusual structures indicates a double shift for the European market. At a basic level, the trimming or eradication of the A tranche highlights the hugely expanded impact of non-bank lenders that invest in all other parts of the capital structure, and the unpopularity with many sponsors of amortising tranches that eat into cash flows. The amenability of bookrunners and investors to the re-ordering of capital structures after launch suggests that the changing investor base is pushing the market towards a public markets model in which structure and pricing are set in the market and books built rather than run.The convergence of the private loan market and the public high yield market model is also seen in the advent of ‘covenant light’ leveraged loans contracts in Europe in early 2007, after the practice had been introduced and accepted by investors in the on high yield issues – in particular non bank investors inclined to buy right across the capital structure. The two initial covenant light deals World Directories and Trader Media, feature contacts with maintenance covenants stripping out, leaving only incurrence covenants. Traditional maintenance covenants allowed investors to regularly test a credits interest cover, leverage, cash flow and capex on a quarterly basis whereas incurrence only covenants mean investors are only able to test a credit when a specific event like a refinancing or an acquisition triggers it. Trimming the amortizing A tranche cuts the draw on sponsors’ cash flow, reducing expensive subordinated tranches in favour of senior debt cuts the cost of capital. Removing maintenance covenants, while it does not impact the cost of capital does increase sponsors’ flexibility and control over their portfolio businesses. Sponsors are armed with huge amounts of money at the moment and competition among them is driving up buyout prices, in that context the ability to finance deals with minimum impact on borrower cash flow is of growing importance. "Banks in turn are competing among each other fiercely to create terms and conditions that will best suit sponsors' interests," said Edward Eyerman, managing director and head of the European leveraged finance team at Fitch. Competition among banks and institutional funds in turn means sponsors are demandi

The three main issues that have prompted comparisons with the US are deal size, US-style repricings and covenant light (which will be examined in another story in this report).Deal size basically means that deals are getting bigger across both sides of the Atlantic but not to the same extent in Europe as in the US. When Danish telecom incumbent TDC was bought out for US$15bn in mid-2006, European bankers believed that the era of the mega-jumbo had arrived and that it was only a matter of time before a €30bn-€40bn deal was done in Europe.However, it did not quite work out like that. It has taken almost nine months for the next true jumbo to happen, which is the £11bn buyout of UK retailer and pharmacy chain Alliance Boots.This deal easily eclipses TDC as Europe's biggest buyout but it has been a long time coming and is still only half as big as the deals being done in the US, where utility TXU has been ought out in a US$45bn transaction and Equity Office Partners in a US$38.3bn deal. That US deals should produce such large transactions is less surprising than the fact that Europe is yet to produce one, because the conventional wisdom is that the European market can finance bigger deals than the US market. The US market is fund-driven, with institutional investors providing about 75% of the debt for any given deal. In Europe, the split is 50/50 and given that banks can write much bigger tickets than funds can, there should be more liquidity for deals in Europe than the US. European leveraged loan banks reckon that €20bn–€25bn can be raised from the European loan market for the right deal, while about €10bn could be raised from the high-yield bond market. Throw in a €10bn equity cheque and you have the necessary financing for a mega jumbo. Kristian Orssten, head of loan debt capital markets at JPMorgan, said that it was only a matter of time before such a deal happened in Europe. "Jumbo deals can get done in Europe – TDC set the ball rolling last year. There's nothing holding people back; it's just a question of finding the right deal with the right story. We are seeing several record-setting jumbo deals in the US and it's just a question of time before we see more deals in Europe. The market desperately needs some jumbo deals that will soak up some of the enormous liquidity that currently exists across all asset classes." One reason that Europe is lagging when it comes to mega jumbos LBOs is that doing deals in Europe was politically and legally more complicated. "Europe is politically more complex and jurisdictional tax regimes have to be favourable for these deals to work," said Orssten. "The equity cheques are very large but with abundant private equity liquidity and the increasingly common phenomena of equity syndicates, this is no longer an obstacle." One factor adding to the complexity of such large deals in Europe is that almost any deal of that size would be a public-to-private transaction and that is where politics often becomes a factor. "Some of the assets best suited to a large buyout are utility and telecoms assets, and they are often seen as extensions of the state in Europe, especially Continental Europe, and that can make things tricky," said the head of loans syndicate at a European bank. Europe goes AmericanaHowever, if the European market lags the US market when it comes to deal size, it is catching up very quickly when it comes to other US norms, and that is especially true when it comes to European borrowers doing US-style repricings, which involve pricing being lowered but not equity being taken out, are new. Firth Rixon's £430m deal, which Lehman Brothers arranged, was the first such transaction in Europe. Firth Rixon's repricing involved the margins on the B, C and revolving tranches being reduced by 25bp, the second-lien tranche by 37.5bp and the mezzanine by 100bp. The repricing received a 100% positive response, allaying any fears that the European market would not accept a pure repricing.A string of s

There is a general sense that globally the market is looking very toppy on just about all measures – valuations, rising leverage, falling equity contributions, disappearing covenants and increasingly back-ended amortisation structures to name but a few.Perhaps the biggest concern is that default rates are virtually zero – against a historical average of 4%-5% – and that the economic cycle has now firmly entered a phase of rising interest rates on both sides of the Atlantic. Bankers, however, are struggling to posit exactly what could burst the bubble.Default rates are certain to rise but they are so low at the moment that even a return to historical averages, which would result in many more default situations than there are present, would hardly be enough to do anything more than trim the market of some of its excesses. Default rates would need to increase beyond their long-term trend rates for the market to crash. What could cause such a crash? Over the past few years global leveraged finance markets have shrugged off major terror attacks, wars, corporate scandals like Enron and Parmalat, hedge fund meltdowns like Amaranth, sustained high oil prices and several years of interest rate rises and none of these have had any meaningful impact.Few people buy into the notion that a new market paradigm is at play, one that says that there is now so much liquidity in the system - and so much liquidity from non-banking sources in the form of institutional investors - that conventional wisdom no longer holds. There is now so much liquidity right down the credit curve that there are buyers at any price that it removes lenders' traditional fear of being left holding paper on a deal they do not want.More realistically, there are many reasons to believe that market fundamentals have not changed at all and that current structuring practices are just storing up future trouble.So what are these dangerous practices? The erosion of covenants is one. Covenants act as an early warning system to lenders that a borrower is in trouble. The looser a deal's covenants, the later lenders find out when that borrower is in trouble. This has two effects. Firstly, as a trend, it delays any market meltdown. There could be all sorts of companies that are struggling right now but not showing up on anyone's radar because covenants are so lax that they have not yet been triggered. Secondly, it means that once lenders find out that a company is struggling, it will be so much harder to rescue that company.The arrival of so called "covenant-light" deals in Europe is a dangerous development for the market and one that is liquidity driven rather than driven by economic fundamentals.These structures began in the US, have made their way to Europe on deals like World Directories and Trader Media Group and even as far as Australia on deals like Qantas. It is worth noting that such structures are now in retreat in the US market, suggesting that caution is on the rise there, even as it is being thrown to the wind elsewhere.Back-ended amortisation structures are another cause for concern, especially in a rising interest rate environment. There are a glut of deals in the US and Europe where amortisation does not begin until two to four years into a financing's life. This means that lenders have no idea whether these borrowers can meet their repayment schedules. Certainly, this can be beneficial to a company because it frees up cash flows shortly after it has been bought out but it does store up trouble for later and interest rates could well be substantially higher when amortisation kicks in.Then there is the trend of subordinated debt being replaced with institutional senior debt, namely much larger B and C tranches. This makes sense for sponsors because it cheapens the debt so, they argue, makes the business more viable.The problem, however, is that subordinated debt in all its forms - mezzanine, second lien, high-yield and all their variations - create a buffer zone betwee