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European leveraged finance: Choosing the right path

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European leveraged finance markets paused for breath in 2022, due to rising interest rates, volatile geopolitics and a tightening of financial markets across the board—but what can we expect in 2023?

Foreword

Heading into 2023, European leveraged finance markets continue to deal with fierce headwinds, following 12 months of economic and geopolitical volatility that has prompted a general slowdown in issuance. What does this mean for the months ahead?

After the record-setting leveraged finance activity seen in 2021—as companies scrambled to refinance, M&A activity spiked and private equity (PE) went on a shopping spree—it was clear that pace was not likely to continue.

But in 2022, as the tail end of the pandemic worked its way through markets, companies were suddenly faced with a new reality. Conflict erupted in Ukraine, oil prices climbed and supply chains were disrupted. A decade of low inflation and interest rates came to an end across Europe. Financing began to tighten as debt became increasingly expensive.

By the end of 2022, while European leveraged loan and high yield bond markets began to see activity, it was well below normal levels and followed a prolonged period of lower issuances. Leveraged loan issuance in Western and Southern Europe was down 37 per cent year-on-year, while high yield bonds fell by 66 per cent during the same period. The third quarter of the year was one of the lowest quarterly totals for leveraged finance issuance in the region on Debtwire Par record.

In both cases, higher pricing was a major factor as it continued to climb throughout the year. On leveraged loans, almost 40 per cent of all deals saw original issue discounts (OIDs) of two or more points from par—by Q4, it was not unheard of for there to be OIDs in the low 90s on term loan B facilities. On the bond side, pricing seemed to finally peak by the end of the year, but only after six quarters of consistent rises.

Eye on the prize

At the same time, there were a few bright spots for leveraged finance markets throughout the year.

First and foremost, buyout activity remained active in the first half of 2022 before dropping off in the second half. Notable deals include KKR’s €3.4 billion-equivalent acquisition of independent beverage bottler Refresco and Bain’s purchase of human resource consultants House of HR, backed by a €1.145 billion term loan and a €415 million note.

Second, new money financing represented a significant proportion of total issuance early in the year, as issuers raised term loan facilities to partially refinance drawn revolvers and fund new acquisitions. As with everything else, however, headwinds meant that most of the new money facilities issued towards the end of the year were smaller add-ons.

Third, CLOs continued to perform consistently (though they were not immune to the general slowdown in the market). Overall, there was €26.1 billion in issuance in 2022—down 32 per cent year-on-year but, in November alone, there was almost €3 billion in new CLO issuance, well above historical monthly averages, according to Debtwire Par.

The path ahead

While there are still shadows on the horizon, the cyclical nature of leveraged finance means that there are always new opportunities. The key is to be prepared.

For example, inflation is starting to plateau in many jurisdictions, but interest rate rises may continue—in the UK, for example, in December, the Bank of England raised the benchmark to 3.5 per cent, up from 3 per cent. This was the ninth consecutive hike since December 2021, placing the rate at its highest level for 14 years. Companies will need to consider their options carefully to get their costs under control.

For those looking to pro-actively manage their debt, amend-and-extend facilities may be the best place to start. Small add-ons and maturity extensions will help many find their way through the forest until macro-economic conditions improve. 

Those with the highest-quality credits will reap the benefits of the liquidity available in the market by upsizing as well as via likely tighter pricing during syndication (when compared to balance sheet lending). For example, Debtwire Par reports that French telephony firm Iliad and automotive supplier Valeo entered the market with €500 million notes, and both were upsized during syndication to €750 million.

While this points to a potentially bifurcated European market in the months ahead, where solid credits remain healthy and those already struggling may face an uphill battle, liquidity on the equity and debt ledgers remains strong, and leveraged finance activity is likely to pick up further to address their respective needs.
 

Hitting the brakes: European leveraged finance battens down the hatches

  • Leveraged loan issuance in Western and Southern Europe reached €183.4 billion in 2022, down by 37 per cent year-on-year
  • High yield bond activity was down 66 per cent during the same period, at €50 billion
  • Loan margins were up by 0.64 per cent by the end of the year, while average yields to maturity for high yield bonds climbed by nearly 3 per cent
tunnel in autumn

Five factors that will influence leveraged finance in 2023

  • Amend-and-extend deals to come to the fore
  • Mid-market deals to take centre stage
  • Secondary market developments will drive primary market prospects
  • Restructurings may rise as maturities approach and cash balances run low
  • Sponsors will find it tougher to source financing, but we may not see a terms evolution
Blue Ridge Parkway

Ready for restructuring

  • Rising interest rates and reduced refinancing options are increasing the likelihood of restructuring and financial distress in the next 12 months
  • Cov-lite debt packages have given borrowers breathing room, but may conceal underlying distress
  • Issuers in stable sectors have negotiated amend-and-extend (A&E) deals to push out maturity cliff edges, but not all borrowers have that option
aerial view of super highways

M&A and buyouts— slowing the pace

  • M&A leveraged loan issuance in Western and Southern Europe is down 69 per cent year-on-year, while high yield is down 81 per cent
  • Buyout loan and high yield bond issuance is down by 9 per cent and 52 per cent respectively
  • Dislocation between buyer and vendor expectations on M&A deals expected to weigh on deal activity in 2023
waterfalls

Getting the deal done: How is European PE securing debt in a tight market?

  • Private equity (PE) deal value in Europe dropped from US$599.2 billion in 2021 to US$369 billion in 2022
  • Private debt fund structures in the region will ensure that buyouts and deal financings continue despite a tough market
  • Debt funds have appetite to fund large-cap as well as mid-market transactions
  • Club deals are becoming commonplace, as direct lenders take on bigger deal financings and diversify risk in their mid-market portfolios
aerial view of road in autumn forest and blue sea

Sector focus: European infrastructure financing flows

  • Global infrastructure debt refinancing issuance reached US$222.8 billion in 2022, versus US$260.7 billion in 2021
  • Infrastructure issuers have been shielded from rising debt costs as most capital structures are hedged or have fixed interest rate charges
  • Rapid growth in provision of infrastructure finance from private debt providers adds to the options open to borrowers
  • Telecoms infrastructure and energy transition key drivers of activity
forest in autumn

European direct lenders step in to fill the gap

  • Direct lenders were able to take on large-cap financings in 2022 as loan and bond markets pulled back
  • Nimble managers are taking out hung bridges and buying up debt in non-conventional syndication processes
  • Direct lending moves into 2023 in good shape, but pressures on portfolios and tighter fundraising markets could slow deployment
aerial view of crossroads in the forest

US versus Europe: On different footing for 2023

  • US leverage loan issuance for 2022 fell 24 per cent, year-on-year, reaching US$1.1 trillion
  • High yield bonds in the US were hit particularly hard, dropping 78 per cent during the same period to US$96.5 billion
  • Leveraged loan issuance in Western and Southern Europe by comparison was down 37 per cent year-on-year for 2022, at €183.4 billion in 2022
  • High yield bond activity in Western and Southern Europe dropped 66 per cent during the same period, to €50 billion
aerial view of forest roads

European leveraged debt in focus

Country focus: United Kingdom

UK leveraged finance markets have come through a challenging period in 2022, with issuance across leveraged loan and high yield markets declining as rising interest rates, inflation and the conflict in Ukraine hit activity.

UK leveraged finance issuance in 2022 fell by just over 50 per cent year-on-year, tracking the drop off in issuance observed across the wider European market. Private debt lending has proven more resilient but has also felt the impact of rate hikes and geopolitical uncertainty, with fundraising markets and deal flow from M&A targets tightening through the course of the year. 

The UK market faced a unique set of challenges. As a result, the Bank of England (BOE) hiked interest rates nine times through the course of 2022 to 3.5, the highest level observed since the 2008 financial crisis. The European Central Bank (ECB), meanwhile, upped rates four times in 2022, with its benchmark rate now sitting at 2.5 per cent to 1 per cent below the BOE level.

UK lenders and borrowers were already contending with political volatility, in the form of successive changes of prime minister and a catastrophic "mini-budget" in late September 2022. This catalysed a slew of collateral calls and forced sales of UK government bonds, requiring the BOE to step in and backstop bond markets to prevent the dislocation from spreading into other parts of the economy. Financing conditions are expected to remain calm in 2023 in the UK, with limited impetus to kickstart markets back into life.

But there are some early signs of green shoots. For example, after raising rates in December 2022, the BOE argued that inflation may have peaked, slowing from the four-decade highs recorded earlier in the year. Assuming inflation has topped out as predicted, there will be more scope for the UK central bank to halt or slow any further interest rate rises. 

A change in the direction of travel on rates will provide issuers and investors with more certainty, help debt prices in secondary markets to recover and encourage primary issuers to come forward and test market appetite for new debt issuance.

The drop in corporate valuations and the weaker price of sterling relative to the US dollar and euro, meanwhile, could drive significant interest from overseas buyers on UK take-private deals in 2023. 

Appetite for UK take-private deals has remained strong in 2022, despite macro-economic headwinds. According to Dealogic, UK companies valued at more than £40 billion were already taken off UK public markets in the first nine months of 2022. Public-to-private transactions are expected to continue providing a pipeline of M&A deals and financing opportunities in 2023.
 

 

Conclusion

Stalled issuance, growing concerns around rising costs, supply chain bottlenecks and the conflict in Ukraine—it's been a whirlwind of a year, with many remaining challenges for the year ahead

aerial view of road and fields
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