Fitch: ECB Plan for US-Style Guidelines May Hit Leveraged Credit
An ECB official said on Wednesday, during a Fitch-moderated panel at the Euromoney European Leveraged Finance conference in Barcelona, that before year-end the ECB will publish an exposure draft detailing proposed leveraged lending guidelines. He said the proposals will be consistent with US guidelines introduced in 2013, under which banks report for examination all leveraged credit exposures, including loans and bonds, where total debt exceeds six times EBITDA.
The proposed regulations would be particularly significant for European leveraged credit markets because banks represent a substantial investor base in the smaller European leveraged credit market compared to the larger, more institutional and retail-oriented US market. In addition, European leveraged credit investors rely on supply from private-equity financial sponsors to a much greater degree than in the US.
Financial sponsors have been at a disadvantage in sourcing assets as they have not been able to match the premium valuations paid by equity markets and trade buyers. Instead, sponsors have turned to paying premium multiples on growth-oriented credits in the financial tech, medical tech, software and business services sectors. These sponsor tactics and their broader return requirements require higher leverage multiples and more borrower-friendly terms and conditions to support leveraged loan supply.
The plan for leveraged lending guidelines adds to the potential uncertainty for leveraged credit markets. The EU is considering higher-risk retention rates on European CLOs, and governments are applying OECD recommendations on corporate tax base erosion and profit shifting, which may capture a portion of the interest deductibility on financial sponsor shareholder loans and payment-in-kind instruments that help support their equity contributions and return targets. Banks and leveraged credit market constituents therefore have multiple regulatory contingencies to plan for as they approach 2017.