Leveraged finance: where did it all go wrong for UK firms?

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  • This is an overly alarmist and slightly inaccurate article. High Yield covenants are no more complex than the covenants in any other form of financing, they are just written in poorer English! So far as commoditisation is concerned, High Yield is one of the very few markets where a determining negotiating stance on any issue is what was done in the last deal, it is the only market where the terms of practically all deals can be looked up on a computer by anyone willing to bnuy the programme. So far as the effect on the UK market is concerned, one has to remember that the total size of the EMEA leveraged finance market, at Euro 67bn in 2013, is a fraction of the total amount of NON leveraged loans worked on by the leading European finance firm (A&O) in 2013, at $167bn. Some perspective in these things would be helpful.

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  • Some facts wouldn't hurt either. Who topped the league tables in Europe for High Yield in 2013 according to Bloomberg? A US firm? No. A&O again. USD67bn worth across 120 deals. Oh and second? Linklaters, with USD63bn across 153 deals. Yep, those magic circle firms are really struggling in this space. To be fair Latham's did do 204 deals in 2013, but worth USD58bn, which gives an average deal value of about USD287m, compared to USD412m for Links and USD564m for A&O. So if you're doing a higher volume of lower value deals - are you really competing at the top end of the market?

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  • It's only really a concern for a handful of firms. Can a valid discussion of a real issue for UK Magic Circle firms be considered alarmist, as such? Not for the wider market.

    The idea high-yield covenants are written in poorer English seems somewhat silly. The individual covenants may not be more complex but the overall package is a de facto public commitment by the borrower to behave in certain ways. They are public debt instruments rather than private loans from banks, which is of course why terms of deals can be looked up.

    Are institutional investors more comfortable perhaps investing in public securities (or funds investing in public securities) than leveraged loans at the moment? Maybe ask Blackrock or others for a view. If debt capital markets are able to offer certain categories of borrowers a lower cost of finance than banks at this point in the business cycle then that's the way the market will go for a time.

    Talking about the size of the non-leveraged finance market is a bit of a red herring. It's an entirely different market, though one even more prone to low-fee commoditisation if we're on the topic. How much will A&O or Linklaters get paid for advising a bank on setting up a new revolving credit facility for a blue chip corporate? Or in the DCM world, for a MTN Programme tap? Not very much at all. So they need volume, market share and high barriers to entry via bank (lender or arranger) relationships to make it work, where the products find a price "floor", from where it's not worth other firms investing in the technology, personnel and bank relationships to compete because of the huge investment costs and risk of failure. White & Case were the only firm to have a proper go at this about 10 years ago and only partially (and temporarily) succeeded.

    The numbers on the size of the market are interesting. The European HY market even after huge growth is what, about 40% the size of the US market? And where are the MC firms in the US league tables? So if you're just about hanging in there at the top in Europe after significant investment but are not really there globally, are you competing at the top of the market, or hanging on by fingernails?

    Perhaps having to invest a lot of money in building high-yield bond practices while simultaneously preferring the product didn't exist, or wasn't becoming increasingly influential, is causing a degree of cognitive dissonance at some firms.

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  • @Robert Elliott: As the Chairman of DebtXplained, the company that lets you look up "the terms of practically all deals on a computer" I thought it might be worth mentioning a couple of things relevant to the piece. You are correct that many US law firms (including tier 1 firms) use our system as do Magic Circle firms and so the notion that there is an exclusive knowledge set with the US firms is indeed mis-founded. It is also worth noting that the High Yield market is consistently expanding in terms of countries and reach. Last year saw deals from jurisdictions such as Romania, Serbia and Bulgaria as well as increased issuance from Southern Europe and it is unlikely that any given firm will be able to keep a knowledge of such a broad range of transactions and thereby block other market entrants. Therefore, in a precedent based market, it seems that the trend of diversification will in fact offer more opportunity for new market entrants and existing practitioners rather than lead to a narrowing of the market or loss of business by some parties. On the leveraged loans side, there is now increased transparency in the market as we have begun tracking loan terms in our Representative Loan Terms database. It is unlikely that over time guarding the terms of transactions can be used as the key competitive advantage of law firms. The knowledge of precedent transactions is becoming increasingly commoditised, as you highlight and perhaps it is now old-fashioned structuring and servicing client needs which should be the distinguishing quality for firms?

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