Fitch: European Leveraged Loan Borrowers Enter a New Cycle

Fitch Ratings says in its latest European Leveraged Loan Chart Book that rising leverage and weaker underwriting standards in the European leveraged loan market are offset by ample balance sheet liquidity and long-dated maturity profiles. Furthermore, European leveraged credit profiles are supported by strong debt-service metrics and high equity cushions implied by primary and public market enterprise valuations.

The stable outlook for the asset class supports the agency's expectations of a decline in default rates in the near-to-medium term, as legacy pre-crisis credits finally run off. Longer term, the increasing embrace of back-ended debt structures highlights an enduring borrower reliance on strong capital market conditions to refinance debt in the future rather than to amortise through cash-flow generation.

Trends in the outstanding credit quality in Fitch's European leveraged loan portfolio reflect distinct market phases and cyclical transitions. The changes in median credit opinion rating profiles over the past eight years, from weak single-B to strong single-B to weak again, reflect the changing mix of riskier pre-2007 or pre-crisis credits embracing amendments and extensions, to the stronger underwriting standards of the post-crisis years, to the current market that signals a return of too much capital in search of too few borrowers.

The link between trends in credit quality and loan capital market liquidity conditions also appears evident, as pre-crisis vintages reflected the low funding costs and asset gathering bias of wholesale funded regional bank investors and CL0 1.0 securitised institutional investors. The conservative underwriting standards inherent in the post-crisis vintages to 2012 reflected high funding costs and capital constraints of surviving bank investors, the par-rebuilding efforts of maturing CLO 1.0 investors and the weaker economic and valuation environment of the eurozone crisis years.

Finally, the current market reflects recapitalised European bank investors, and the return of CLOs in 2013 and 2014 in more conservative 2.0 structures together with a rapidly expanding institutional investor base of credit funds and "Direct Lending" funds from traditional fixed-income and alternative asset management platforms. The clear decline in underwriting standards from 2013 to 2015 in comparison to the post-crisis period of 2010 to 2012 also highlights greater investor confidence in the European policy environment and economic outlook.

The mix of credit profiles can change rapidly given the unconstrained ability of loan borrowers to refinance as capital market conditions improve. Over the past year, active refinancing and the increasing acceptance of borrowers from riskier sectors and more aggressive structures contributed to increasing the proportion of 'B-' and below rated issuers to 50% of Fitch's leveraged credit portfolio. However, the credit quality of the portfolio remains broadly stable. A post-crisis low of only 13% of the portfolio is considered "at-risk", with ratings at 'B-' with a Negative Outlook or below. Maturities remain long-dated and the low-interest rate environment provides cash flow flexibility. In parallel, the number of these 'at-risk' borrowers from 2006-2007 vintages has declined, as a majority of them eventually became the targets of trade buyers or actively refinanced (or extended) maturities, while the weaker borrowers experienced some form of distressed debt exchange.

In this edition of the Chart Book, the agency has introduced median credit statistics for different cohorts of issuers within the portfolio. Issuers with subordinated debt that carry high total leverage or those with a small size (below EUR200m of debt committed) tend to cluster at the lower end of the 'B' category, as they often exhibit vulnerable business models and/or limited deleveraging prospects in a weak top-line growth environment. Moreover, leverage levels tend to reflect business risk profiles, with healthcare issuers generally supporting higher leverage than industrials at a given rating level for example.


Fitch's latest European Leveraged Loan Chart Book includes new data on loan performance, as well as recent trends in issuance, maturities and default rates. The data and analysis is based on Fitch's portfolio of private credit opinions, private ratings and public ratings on 418 European leveraged credits (as of April 2015), primarily LBOs, representing around EUR350bn of committed senior and junior loan debt.