Four buyouts, backed with loans yet to be syndicated in Europe’s leveraged loan market, are expected to include pre-placed second-lien loans, including Danish packaging group Faerch Plast; European industrial supplies distributor IPH Brammer; cleaning business Safetykleen Europe; and Hong Kong-based international schools operator Nord Anglia Education.

By going directly to funds, buyout firms are guaranteeing placement on the most expensive and risky part of a capital structure, avoiding any costly risks that could arise during a syndication process. 

“Borrowers are happy to lock in the terms. They don’t have to take market risk with syndication and as second-lien providers can’t get enough of the paper, they are offering competitive terms,” a senior leverage finance banker said.

The removal of a subordinated piece of debt from an underwrite is impacting banks that are already being squeezed on fees on the senior part of a capital structure to around 1.5%-1.75%, from 1.75%-2.25% a couple of years ago.  Second-lien fees come in anywhere between 2%-3%.

Subordinated second-lien loans have become attractive to sponsors as a means of increasing overall leverage on a deal, while maintaining control over who holds the paper -- something that cannot be achieved via the public high-yield market.

Second-lien loans also don’t have the restrictive call protection associated with bonds.

Other pre-placed second-liens this year include deals for UK-based Element Materials Technology, Swedish dialysis clinic operator Diaverum, British holiday park operator Parkdean Resorts and Belgian aluminium systems manufacturer Corialis, among others.

Funds available to take pre-placed second-lien loans include Alcentra, Apollo Capital Management, MV Credit, Ares, Park Square Capital, EQT, GSO and Partners Group.   

MARKET RISK

Despite banks losing out on the 2%-3%underwriting fees, sponsors are having to pay out that same amount to the funds they are pre-placing the paper with, in the form of an arrangement fee.

Sponsors are, however, protected from market risk if a deal goes wrong.  Typical market flex on a struggling deal could see a sponsor on the hook for an additional 150bp.

“The reality is that there is no real difference in terms of overall fees. The margin may be wider on a pre-placed second-lien loan compared to an underwritten deal, but there is also no flex,” a leverage finance head said.

Deep liquidity in Europe’s leveraged loan market, where demand far outweighs supply, has seen pricing compression. In some cases Single B issuers are achieving market lows of 300bp on first-lien paper and arguably sponsors will achieve market lows on second-lien paper.

KKR paid 675bp over Libor with a 0% floor and 650bp over Euribor with a 0% floor for a $20 million (£15.4 million) and €20 million (£17.3 million) second-lien add-on tranche for UK forensic sciences group LGC in January.

Some banks are approaching sponsors to argue a case for syndicated second-liens. A syndicated deal in such a hot market could price significantly tighter than a pre-placed loan.

However, many of those funds are telling sponsors they will not buy the second-lien paper if it is syndicated.

“Some funds are telling sponsors they will not take second-lien unless it is pre-placed, as all-in yield on syndication is lower. They have remits to do big tickets and they want good yield and a substantial amount of paper. It is a threat but it is a legitimate one because if it goes to a wide syndication and these funds are offered a smaller ticket at a lower yield, they will probably walk away,” the leveraged finance head said.

In a search for yield, there are alternative funds that may be attracted to second-lien paper that may not have otherwise been in different market conditions.

“If banks go to the broader market with second-lien paper there is a base of investors out there in possession of subordinated baskets and in search for yield, so they may be willing to buy,” the leveraged finance head said.

A syndicate head said: “Investors holding sponsors to ransom may be relevant around some very big tranches where you need big ticket commitments but on the smaller second-liens of around €100 million you could sell €10 million - €15 million tickets to various funds.”

(Editing by Christopher Mangham)

By Claire Ruckin