Not too many years ago, the U.S. and European leveraged loan markets operated as two distinct enterprises, each with its own separate group of underwriters, investors, and private equity firms. Today these two regions are rapidly evolving into a transatlantic marketplace. To be sure, each market still has its own discrete personality. But they are now integrated in ways unimaginable just five years ago. For one thing, U.S. private equity firms are increasingly active in Europe. In 2005, among the top 25 LBO shops in Europe by transaction volume, 10 were U.S.-based. This is up from five in 2000.
Of course, the big sell-side arrangers have long had global footprints. But the recent trend toward an alignment of the nonbank investor base for U.S. and European loans is clearly a major development that has already had a wide impact on the leveraged loan market and promises to continue. The reason why this is happening now is simple: Just as nature abhors a vacuum, financial markets abhor an illiquidity premium, and U.S. accounts are racing to get a piece of Europe's relatively high spreads.
Thus, Europe has become a primary focus for U.S. accounts because of two forces. First, Europe offers a much-needed source of collateral (see "European Loans: Demand Soars Even As Ratings Slide," published April 24, 2006 on RatingsDirect) while U.S. loan investors are starved for product. Indeed, European leveraged loan volume jumped to a record €37 billion ($44 billion) during the first quarter of 2006--a new high--from €32 billion in the fourth quarter and from €21 billion during the opening three months of 2005. Likewise, institutional volume also hit a record, compiling €22 billion ($26 billion) during the first quarter, up from €14 billion during the fourth quarter of 2005 and from €9 billion during the comparable period of last year.
Second, Europe still offers U.S. accounts relatively high spreads. During the first quarter, in fact, spreads of institutional new issues in Europe were, on average, 15 basis points (bps) wide of the U.S. market, at LIBOR plus 279 bps (L+279), versus L+264. Drilling down through the ratings categories, European spreads on loans rated at the 'BB' or 'BB-' level were, on average, a hefty 76 bps higher than those in the U.S., at L+244, versus L+168, while the gap for B+/B rated loans was 27 bps (L+254 versus L+281).
"Mega-Jumbo" Deals Are On The Rise
In the secondary market, the story is much the same. The average discounted spread of U.S. institutional loans in the Standard & Poor's/Loan Syndications And Trading Association (S&P/LSTA) Index ended March at L+220, 62 bps inside that of discounted European spreads of L+282, according to Standard & Poor's European Leveraged Loan Index (ELLI). It breaks down the same way by rating. For 'BB' rated loans, the discounted spread in the U.S. is 91 bps lower at L+162 (versus L+253), while for 'B' loans, the gap is a more modest 45 bps, at L+241 (versus L+286).
For these reasons, it seems as though every U.S. account has either set up a shop in London, is in the process of doing so, or is actively exploring how to go about it. By our count, the number of U.S. investor groups active in Europe grew to 33 during the first quarter, from 26 at year-end and from 13 a year earlier. Arrangers in Europe believe this number will stand at upwards of 50 by year-end.
It is not just investor groups that are becoming more global in nature; deals themselves are as well. During the first quarter, the volume of cross-border leveraged loan volume surged to €17 billion ($20 billion) on the back of last year's all-time record of €31 billion ($37 billion). Just seven deals accounted for €14.6 billion of this volume--evidence that cross-border syndications usually finance sizable transactions. Both 2005 and year-to-date 2006 saw a number of "mega-jumbo" deals, including €6.3 billion of syndicated bank debt for Ineos' acquisition of Innovene this year and €7.6 billion of bank debt for Wind Telecomunicazioni's 2005 LBO (both amounts include second-lien debt). As a result, the average bank loan size through the second lien stood at €2.1 billion for year-to-date 2006 deals and €1.7 billion for 2005 deals.
An Increasingly Common Pool Of Firms Will Develop
While most cross-border transactions involve issuers with businesses on both sides of the Atlantic, European companies dominated the 2006 pool of deals, with five out of seven issuers domiciled in the U.K., France, Netherlands, or Switzerland. And the majority of the cross-border volume this year has been raised by European lenders. At €7.6 billion, that share is already at 51.5% of last year's entire amount of €14.8 billion. The U.S. component for this year stands at €6.9 billion, or 42.3% of last year's €16.3 billion.
In the first quarter of 2006, leveraged loan volume shot to unprecedented heights in both Europe and the U.S. With both regions in record territory, global volume totals are impressive indeed. During the first quarter, combined North American and European loan volume hit $153 billion, from $114 billion during the fourth quarter and from $109 billion during the comparable period last year. At this pace, global loan volume will reach $612 billion--a 37% increase from 2005's record figure of $448 billion. Looking ahead, most participants think the trends toward a transatlantic leveraged loan marketplace will accelerate with an increasingly common pool of private equity firms, sell-side firms, and buy-side firms conducting business on either side of the pond.
(Leveraged Commentary & Data is a unit of Standard & Poor's, not affiliated with the Ratings Group.)
