Debt funds to benefit from ECB leverage rules

Private debt funds will benefit from proposed EU rules that will make it more difficult for banks to lend into leveraged transactions, according to law firm Hogan Lovells.

The European Central Bank’s rules, equivalent to the US Guidance on Leveraged Lending, require credit institutions to conduct in-depth due diligence on the sustainability of the borrower’s debt and a risk assessment against the lender’s risk appetite in cases of a leveraged transaction.

The ECB considers a financing transaction to be leveraged if a borrower’s post-financing liabilities exceed a four times multiple of the last 12 months realized, unadjusted EBITDA or a borrower is controlled by one or more financial sponsors (including private equity firms) and the borrower has any loan exposure.

“This is likely to create further opportunities for unregulated private debt funds, as credit institutions are likely to become more risk averse and abstain from participating in highly leveraged syndicated loans,” Hogan Lovells said in a client note.

Around one-fifth of private equity sponsored financial transactions are levered at more than six times EBITDA in 2016, and the average is 4.7, so the ECB guidance will have an impact on a significant portion of leveraged lending by credit institutions into private equity backed transactions.

“The guidance will not, however, have an impact on unregulated credit funds lending on leveraged transactions, which gives these private direct lending funds greater flexibility to lend when compared to credit institutions,” the law firm said.

Final guidance on the rules is due to be published by the ECB soon, although there is no timeline.