May 18, 2017 - In response to the strong recovery of the European leveraged finance market and the rise of borrower-friendly conditions that have been imported into the European market, the European Central Bank released its final guidance on leveraged transactions on May 16th. Approximately six months in the making, the guidance comes after a public consultation period on the draft guidance from which many, but not all, industry comments were accepted. The ECB Guidance applies to all "significant credit institutions" supervised by the ECB under the Single Supervisory Mechanism ("SSM") but therefore, would not apply to nonbank lenders. The initial release indicated that the goals of the ECB Guidance are aligned with the Leveraged Lending Guidance published by the U.S. bank regulators in 2013, and responding to industry comment, many of the changes seen in the ECB's final guidance is to bring the two closer in line.
As summarized by Debevoise & Plimpton, the final guidance still includes in its definition of leveraged transactions those loans or credit exposures where the borrower's post-financing total debt to EBITDA exceeds 4x; and/or where the borrower is 50% owned by a financial sponsor, however, it clarifies that “Total Debt”, calculated at the borrower group level, now applies to total committed debt (including drawn and undrawn amounts) and any additional debt that loan agreements may permit. Moreover, cash must not be netted against debt in this calculation – a clarification requested by industry commenters. Importantly, the ECB responded to industry comments and the Guidance now contemplates a definition of EBITDA, for purposes of calculating total debt leverage, that permits enhancements which are duly justified and reviewed independently from the front office function. With respect to exclusions from the Guidance, new types of transactions have been added, such as loans to investment grade borrowers and loans to small and medium-sized enterprises that not owned by one or more financial sponsors. Commenters requested that the €5M threshold for excluded transactions be raised, but the ECB declined. The ECB Guidance, like its U.S. counterpart, states that transactions presenting a total leverage in excess of 6x should remain exceptional. Similarly, the ECB Guidance recommends that borrowers should show the cash-flow ability to repay all of their senior debt or at least half of their total debt in five to seven years (or “to delever to a sustainable level”). The ECB Guidance will go into effect six months after its publication.
We will be analyzing the European guidance (and comparing to the U.S. guidance) in more detail at the LSTA and LMA Joint Conference on May 23rd in NYC.