03 January 2017

Reuters: ECB lending guidelines could drive riskier LBOs underground

Proposed leveraged lending guidelines from the European Central Bank could force riskier lending into unregulated channels and create unintended opportunities for arbitrage as well as breed market distortion.

In an attempt to curb banks from underwriting riskier LBOs, the European banking watchdog has put forward a red line of 6x leverage in its draft guidance on "leveraged transactions", closely mirroring guidelines introduced by US regulators in 2013.

Fears are growing, however, that Europe could see similar unintended consequences to the US, where the introduction of the threshold has driven highly leveraged lending underground.

"It's a bit of a game of whack-a-mole, because not only will the non-bank lenders step into the breach and provide larger and larger loans, but what we've seen happen in the US is that the banks have actually stepped up their lending to these private credit institutions," said Luke McDougall, a leveraged finance partner at Paul Hastings.

US private credit and direct lending funds once specialised in mid-market buyouts. However, they have raised enough firepower in recent years to supplant the institutional high-yield bond and leveraged loan packages typically required for large-cap deals, such as Thoma Bravo's US$3bn take-private acquisition of data analytics firm Qlik Technologies in June.

A senior manager at a London-based credit fund that specialises in direct lending said the ECB's proposed rules would only hasten the debt market's shift into "unregulated channels".

"It makes no difference to us whether a deal is publicly syndicated or not, but if I was on the cap markets desk at a bank, I'd be worried," he said. "You're only going to see more and more self-syndicated deals."

One leveraged finance banker said that direct lending funds are already targeting more highly leveraged transactions than banks, irrespective of the ECB's new regulation, however.

And a second banker said he thought that concerns around leverage were "neither here nor there", as there is "no regulation on any terms" in the direct lending market.

Full news

© Reuters