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Iceland Foods too hot to open LBO freezer

09 Apr 2012

The reception given by investors to Iceland Foods’ debut leveraged loan was anything but frosty. But it would be unwise to draw any hasty conclusions from its success. Expect the LBO market to remain a cold and lonely place for a while yet.

Could it be that there is some momentum building at last in Europe's leveraged loan market? Consider a couple of recent deals. The leads on Iceland Foods' £885m loan managed to reverse-flex the margins on its euro term loan ‘B’ by 50bp to 500bp — and upped the sterling tranche. French catering firm Elior also nailed the 500bp tight end of talk for its €200m acquisition facility.

Iceland can now be added to 2012’s impeccable record of LBO deals to have cleared the market successfully — Orange Switzerland, Taminco, CPA Global and Ahlsell.

These are surely heady days compared to the second half of 2011, when flex (rather than reverse-flex) terms were regularly being maxed out and large original issue discounts (OIDs) were causing headaches and losses for arrangers.

So are the days of record 550bp margins over? No. And it would take a remarkably aggressive — or foolish — underwriter to believe so.

Elior may have been closed successfully, but a small add-on facility for a well-established, strongly-performing credit is hardly indicative of market sentiment.

At first glance, Iceland is a more likely bellwether. It required a large amount of new money and was looking for as much sterling as possible — very difficult for CLOs. But Iceland is no normal LBO.

First, its Ba3/B+ rating puts it a cut above most LBO credits, and understandably excites CLO managers. Second, the recovery rate on defaulted leveraged loans in the UK compares favourably to most of Europe, adding to Iceland’s attraction.

Iceland is simply too strong a credit for its success to breed confidence. The only conclusions to be drawn are meagre: that investors are willing to play in the primary market, and that they will accept slightly lower (though still lucrative) pricing for a better credit. Big deal.

Most importantly, looking back at this year’s list of deals tells us that, unlike last year, deals being syndicated in 2012 have had virtually no competition in the market. At a time when new money is merely trickling into the market — with no new CLOs in sight — a barren supply line is needed to successfully sell down a loan.

The fundamental dynamics of the leveraged loan market have not changed: it is strangled by a shrinking pool of capital (thanks to deleveraging banks and expiring CLO reinvestment periods).

Rather than provide confidence for new deals, Iceland’s success simply eats away at the existing pool liquidity, reducing capacity for any LBOs being prepared at the moment. Underwriters remain scared of bringing deals into a crowded market — and rightly so. Investors believe this year’s low volumes have been just right for the buy-side’s capacity.

So it would not be unfair to say leveraged lending is a dysfunctional market. It shows how low standards have become when two deals being allocated in a week feels like a busy period.

This is the most worrying aspect. If there is no product, how can the efforts of loan managers to raise money be fruitful?

The leveraged loan market had better pray that its high yield cousin continues its resurgence — bringing with it the short-term relief of repayments, but also the longer-term chance of stronger LBO dealflow. 
09 Apr 2012