Creditflux Newsletter

In the US, investors are fighting for survival. In Europe, it seems they’re still worried about securing their next allocation of debt

What is the difference between a US loan investor and a European loan investor? No, this is not the start of a bad joke, although flippant answers such as "about 20 points" do spring to mind. The truth is that European loan specialists have spent most of the past 10 years in thrall to private equity fund managers - the "sponsors" of the leveraged buyouts that produce the debt they invest in.

The name of the game was getting "allocations". Leverage ratios, ebitda forecasts and industry diversification were secondary concerns. The constant scarcity of European loans forced investors to sacrifice credit selection. "Big CLO managers made a bargain with the sponsors," recalls one investor. "They said to CVC, Apax or whoever, give us decent allocations and we will buy every deal you bring."

A similar thing happened across the Atlantic, but it was never quite as one-sided. And since the credit bubble burst, US loan investors have been quicker than their European counterparts to take aggressive measures. This approach can be seen in the big fees lenders have demanded for making loan amendments. It is also reflected in legal challenges where debt investors see value leaking down the capital structure, such as debt holders' recent legal action against Freescale's debt exchange.

Some of this may be replicated behind the closed doors in the more private world of European lending. But the early, mostly anecdotal evidence is that loan investors are being much more acquiescent than US lenders.

Partly this reflects that slippery concept called culture. US business culture, for all its faults, encourages an ability to turn on a dime. Your best friend becomes your greatest enemy overnight. Lenders can switch in an instant from sycophantic salesman to hard-nosed adversaries. Europe, by contrast, prizes long-term relationships and partnerships.

Partly the difference is one of jurisdiction, reflecting the greater uniformity and certainty of the legal environment in the US. The final card in the US borrower's pack is chapter 11 bankruptcy, which is likely to be far more painful for the company's managers and equity owners than its creditors. In Europe, by contrast, the threat of bankruptcy - a black hole that could swallow the remaining value of a company in court fees - is more like a gun held to creditors' heads.

But mainly, the difference is to do with experience. Most US loan managers have been in the game long enough to know that when the market turns it is time to get aggressive. The European leveraged loan market is much younger.

Several insiders say that European lenders, CLO managers in particular, have simply failed to make the adjustment from seeing private equity firms as providers of their next deal to foes in a war to extract value. The result could be immense destruction of value for European debt holders. To date, there have been few examples of defaults or public debt restructurings in Europe. However, Moody's is predicting higher default rates for European high yield borrowers than US names.

It is too early to say how European loans will compare to US assets in terms of recoveries. So far, they have been abysmal on both sides of the Atlantic. But the danger is that a supine attitude on the part of lenders could lead to lower recoveries in Europe than in the US.

European loan investors need to make the switch from competitive takers of loans to enforcers of senior lending agreements. Otherwise, they will not survive.