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US leveraged finance: The road ahead

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What will drive issuance in a post-COVID-19 world?


Halfway through 2021, we take stock of leveraged finance in the United States and consider the road ahead for both borrowers and lenders. After more than a year of COVID-19, are things returning to normal? Or are we just starting a whole new journey?

In many ways, COVID-19 had far less of an impact on leveraged finance markets than expected. Activity dropped in the second quarter of 2020, primarily in leveraged loan issuance, but a year later numbers returned to pre-pandemic levels. In fact, leveraged loan and high yield bond values reached record highs by the end of Q1 2021—the highest quarter since Q2 2018 and the second-highest quarter, respectively, on Debtwire Par record going back to 2015.

What drove this relatively high-speed recovery? First, the Coronavirus Aid, Relief and Economic Security (CARES) Act, signed into law in March 2020, protected many businesses from the full brunt of the pandemic. At the same time, many businesses shored up their finances, taking on debt to ensure liquidity as lockdown measures continued to have an impact through the second half of 2020. Issuances rose and that upward trajectory carried on into 2021.

By the end of Q1 2021, the picture had changed once again. Vaccines were being distributed quickly and efficiently, raising hopes for a post-COVID-19 future. The economy was also improving, as various states began to open up and a year of pent-up consumer demand was released. By May, core retail sales in the US had reached levels typically only seen over the Christmas period, according to the National Retail Federation. An air of optimism crept into the market, with lenders increasingly willing to take more risks on borrowers in their pursuit of yield. Financing earmarked for M&A and buyout activity also began to climb, hinting at growth plans for the months ahead. Perhaps most significantly, the low interest rate environment gave businesses an opportunity to reprice and refinance their maturing debt in droves.

What's next for 2021?

While these are all very positive signs for lenders in the leveraged finance space, there are still a few red flags on the horizon. First is inflation—in July, the Bureau of Labor Statistics reported that the US consumer price index had climbed 5.4 percent in the 12 months to June, a level not seen in 13 years. These growing inflationary pressures are part of the rush to reprice and refinance existing debt, as businesses try to avoid any unpleasant surprises if interest rates begin to climb as well.

Second, companies in robust sectors that enjoyed a degree of preferential treatment from lenders during the pandemic may find that sentiment shifting in the months ahead as other sectors begin to recover. The "flight to quality" witnessed in the early days of the pandemic will likely return to a more evenly balanced state of affairs. Documentation may also go through some changes in the coming months, as adjustments brought in during COVID-19 are phased out.

Finally, as the dust settles in debt markets, issues that were gaining ground before the pandemic will return in force, especially environmental, social and governance factors, which continue to take on increasing importance among borrowers and lenders alike.

All of which means the road ahead is not quite as clear as many would like, but there will be fewer obstacles blocking the path.

The US leveraged finance story so far

  • Leveraged loan issuance reached US$763.5 billion in the first half of 2021, up 60 percent from US$478.1 billion in the same period in 2020
  • High yield bond market issuance also rose 22 percent year-on-year, from US$219.6 billion to US$267.1 billion
  • Refinancings and repricing deals accounted for 62 percent of overall loan issuance in H1 2021
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From closing loopholes to rising inflation: Five trends that will drive leveraged finance

  • Leveraged loan and high yield bond markets shrugged off COVID-19 uncertainty to post year-on-year increases in issuance in 2021
  • Features of documents through the COVID-19 period—such as liquidity covenants and EBITDAC metrics—are fading from the market
  • Lenders are increasingly sensitive to the risk of subordination in either right of payment or lien priority
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Fund finance: New ways to harness NAV finance

  • Anecdotal evidence points to a surge in uptake of net asset value finance over the past 12 to 18 months
  • NAV finance is useful for the prevailing longer PE holding periods, which climbed from 3.8 years in 2010 to 5.4 years in 2020
  • Deloitte estimates that the average loan-to-value ratios for NAV facilities sit in the 25% to 30% range
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Downgrades, defaults, distressed debt and refinancing

  • Refinancing and repricing in US leveraged loan markets surged to US$471.7 billion over the first six months of 2021
  • US high yield bond refinancing accounted for 70 percent of total high yield issuance
  • Amend-and-extend deals give borrowers further breathing room
  • The extension of maturities has reduced near-term risk of default and limited the number of borrowers running out of cash and facing bankruptcy
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A more sustainable approach to debt financing

  • Global green bond issuance reached US$305.3 billion in 2020, according to Bloomberg data
  • Ratings agency Standard & Poor's forecasts that global issuance of sustainability-linked debt instruments will exceed US$200 billion in 2021
  • President Biden has pledged to cut US carbon emissions to at least 50 percent below 2005 levels by 2030, advancing the ESG agenda
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Ongoing SPAC surge reshapes capital structures

  • 248 SPACs listed in 2020, raising US$82.6 billion—a more than six-fold rise on 2019 issuance
  • 362 SPAC vehicles raised US$110.2 billion in H1 2021
  • 176 M&A deals worth more than US$386.1 billion have been completed via SPACs in H1 2021
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How distressed companies are avoiding full-blown bankruptcies

  • Announced US corporate bankruptcies climbed to 630 cases in 2020, according to Standard & Poor's—up from 2019 levels, but still lower than expected
  • Bankruptcies ticked higher early in 2021—from 14 cases in January to 23 cases in March, before dropping to 11 in June—but are still well below 2020 levels according to Debtwire Par
  • Covenant relief and uptiering, as well as drop down deals and other liability management structures have offered companies a variety of levers to pull to avoid entering bankruptcy situations
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Energy transition: Financing the race to net zero

  • Green bond issuance climbed 13% in 2020, to US$305.3 billion
  • Global energy investment will have to increase more than three fold to US$5 trillion by 2030 if net-zero carbon emissions are to be achieved by 2050
  • At the start of 2021, renewables accounted for more than 20 percent of total energy generation capacity in the US, surpassing the use of coal
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Direct lending in the US post-COVID-19

  • North American private debt fundraising increased by 15.8 percent in 2020 despite falling fundraising in other jurisdictions
  • The private debt default rate never rose above 2 percent in 2020 and was lower than high yield bond and leveraged loan default rates
  • Current private debt yields of 7 percent are outpacing high yield bonds and leveraged loans
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Refinancing, repricing, M&A and buyout activity all surged in the early months of 2021, but then lenders shifted gears in pursuit of yield and borrowers realized they could tap the market for more than just liquidity. Where will this fork in the road lead for the rest of 2021?

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100 US dollar banknotes scattered

Direct lending in the US is in good shape post-COVID-19

5 min read


  • North American private debt fundraising increased by 15.8 percent in 2020 despite falling fundraising in other jurisdictions
  • The private debt default rate never rose above 2 percent in 2020 and was lower than high yield bond and leveraged loan default rates
  • Current private debt yields of 7 percent are outpacing high yield bonds and leveraged loans

After a volatile and challenging year, US direct lenders moved into 2021 with reputations enhanced and teams strongly positioned to fund new deals. But we cannot discuss current direct lending in the US without casting a slightly wider net for comparison.

According to data collected by Preqin and analyzed by McKinsey, global private debt fundraising (where direct lending represents the largest amount of capital) fell by 6.7 percent to US$124.4 billion in 2020, as COVID-19 saw investors put commitments to new funds on hold. The North American market, however, bucked the global trend, with private debt fundraising up 15.8 percent year-on-year at US$79.8 billion.

This growth in private debt fundraising is conclusive evidence that the North American direct lending space has matured into a credible, established industry, able to operate through credit cycles.

Despite pandemic disruption, private debt markets have continued to benefit from the long-term regulatory trend following the 2008 global financial crisis, according to McKinsey. Regulatory developments established post-crisis constrained traditional bank lending channels and gave non-bank direct lenders an opportunity to win market share and expand their franchises. A prolonged period of low interest rates and dovish monetary policy have also supported the direct lending industry's growth.

Private debt portfolios also appear to have been less impacted by pandemic volatility. As private credit assets are not traded publicly and held in closed-ended fund structures, they are less exposed to market volatility.

This idea is reinforced by a Q1 2021 research note from private markets investment platform Adams Street, finding that private debt default rates never rose above 2 percent in 2020, while leveraged loan and high yield bond default rates came in at around 4 percent and 10 percent respectively.

US investment manager Nuveen notes further that, as the market for private credit investments is illiquid, managers in the space have also taken a more conservative approach to credit risk. Unlike high yield bond and leveraged loan investors, who have the flexibility to trade out of underperforming assets as required, private credit managers follow "buy-and-hold" strategies, which has seen them show a proclivity for funding deals in defensive, asset-light sectors.

In addition, private credit managers often align with borrowers backed by private equity (PE) firms with specific industry/operational expertise, which adds a layer of downside protection.

Private debt funds, however, have not only proven effective at mitigating downside risk. Managers have also continued to deliver returns for investors. According to Adams Street, private debt funds have produced current average yields of approximately 7 percent, versus average yields of 4.73 percent for high yield bonds and 4.61 percent for leveraged loans.

According to Adams Street, private debt funds have produced current average yields of around 7%, versus average yields of 4.73% for high yield bonds and 4.61% for leveraged loans


Perfect positioning

As the US economy has reopened, direct lenders have shifted attention and resources back to new deals and are well-placed to continue securing new deal flow and deliver superior returns to other fixed income classes.

According to Nuveen, the potential pipeline of transaction opportunities for private debt managers looks promising. The ratio of dry powder held by PE firms (the primary users of private debt capital) versus private debt funds sits at 5:1. As private market M&A deals are typically structured with debt of between 50 percent and 75 percent of total pro forma capitalization, the ratio of debt dry powder versus PE dry powder would have to shift to between 1:1 and 1:4 before there was any risk of private debt market saturation. All of which means post-pandemic supply-demand dynamics still favor private debt managers.

Furthermore, Nuveen's analysis notes that, while the COVID-19 downswing is very different from other economic downturns, private debt vintages launched in downturns have historically outperformed other years, with 2001 and 2009 being the two best-performing private debt years on their record to date.

The growth in private debt assets under management has also meant that direct lenders have been able to compete for credits that would otherwise have defaulted to either the syndicated loan or high yield bond markets.

Some direct lenders have the capacity to digest credits of up to US$1 billion or form lending clubs with each other that can cover check sizes of up to US$3 billion.

Direct lending has served as an attractive option for borrowers, especially PE sponsors, due, in part, to the speed of execution of direct lending transactions and the fact that pricing and other terms applicable to these transactions are not subject to modification due to market flex provisions.

In addition, PE sponsors appreciate the simplicity of working with a single or small group of lending counterparties rather than a large mix of lenders in a leveraged loan syndicate.

Competing with the syndicated loan and high yield bond markets means direct lenders have had to tighten the pricing of their loans and, in some cases, lend on covenant-lite terms, which until now has not been a feature of direct lending documentation in the core mid-market.

The active selection of credits and PE-backed borrowers by direct lenders, the large sums of liquidity at their disposal and the resilience of their portfolios following the pandemic period, however, suggest that direct lenders are well positioned to continue expanding their platforms and take on increasingly large tickets in the year ahead.



White & Case means the international legal practice comprising White & Case LLP, a New York State registered limited liability partnership, White & Case LLP, a limited liability partnership incorporated under English law and all other affiliated partnerships, companies and entities.

This article is prepared for the general information of interested persons. It is not, and does not attempt to be, comprehensive in nature. Due to the general nature of its content, it should not be regarded as legal advice.

© 2021 White & Case LLP

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