European leveraged finance: From survive to thrive
European leveraged finance markets rebounded in the past 12 months, driven by enthusiastic refinancing activity and a resurgent M&A marketplace, setting the stage for a healthy year ahead
European leveraged finance markets look remarkably healthy as we enter 2022. This may come as a surprise, after 12 months of economic volatility underpinned by everything from a new COVID-19 variant to growing inflationary pressures. What does this mean for the months ahead?
The start of the new year is full of positives in the European leveraged finance market. There has been a clear shift from survival to growth strategies among lenders and borrowers, setting the stage for significant activity in almost all sectors.
The numbers paint a clear picture. European leveraged loan issuance climbed more than 25% in 2021, year-on-year. High yield bond markets in the region were even more enthusiastic, with issuance for the year up 47% on 2020's total.
Ongoing government support in the EU and the UK helped companies that might otherwise have fallen victim to the pandemic stay afloat. Low interest rates and pricing sparked a wave of refinancing. CLO activity—most of which was intended for refinancing and resets—pushed new CLO issuance up by 75% year-on-year.
A bottleneck of demand as well as significant private equity dry powder also brought a flood of new deal money into the market. Companies that were once hesitant to sell encountered enthusiastic buyers aggressively looking for targets. Buyers, meanwhile, found themselves in a better position to judge whether a potential target was likely to struggle or grow in 2022 and beyond. Lenders reaped the benefits, with high deal volume in which to participate. At the same time, unlike many other industries, European direct lending funds avoided any significant downturn in deployment and deal activity due to COVID-19. According to data from Debtwire Par, direct lending issuance in the region reached €36.2 billion in 2021, surpassing 2020's full-year total of €21.4 billion. This provided a liquid and competitive market for finance products.
Possibilities and pitfalls
Set against this positive backdrop, does the future look entirely bright for leveraged finance? Not necessarily—some challenges remain, and each may have an impact on European issuance.
For example, climbing COVID-19 case numbers driven by the Omicron variant may convince some corporates to hold on to their reserves. Any resulting new lockdowns or restrictions could also be the final straw for businesses that have already struggled during the pandemic.
Inflation and attendant interest rate rises are also likely to influence potential borrowing decisions in the coming months. The UK got the ball rolling with its first interest rate rise in three years in December 2021, and the EU may follow suit in 2022—despite claims to the contrary by the European Central Bank.
Any rise in the cost of debt will affect M&A and buyout activity, as well as financing. Some may pause while others—from corporates in good financial shape to PE firms with money to spend—may decide to invest in a post-COVID-19 future. Either way, M&A and buyout deals in the pipeline already suggest that issuance will remain healthy in the first half of the year at least.
And, finally, environmental, social and corporate governance criteria will be on the menu for every European business. New benchmarks due in 2022—from the EU's Sustainable Finance Disclosure Regulation to the European Leveraged Finance Association's updated Sustainability Linked Loan Principles—are already making lenders and borrowers sit up and take notice.
All this activity means the stage is set for companies hoping to thrive rather than simply survive. Lenders chasing higher-yield opportunities will be on the hunt for new investments, and borrowers can be expected to provide lenders with a healthy volume of demand for debt financing in 2022.
From survive to thrive: European leveraged finance looks to the future
European leveraged loan issuance was up by more than a quarter, year-on-year, to €289.7 billion in 2021
High yield issuance reached €148 billion in 2021, up 47% on 2020 (year-on-year)
Refinancing accounted for approximately half of overall leveraged loan and high yield bond issuance for the year
Both M&A and buyout activity saw double-digit year-on-year rises in deal-related issuance
A flurry of activity saw year-on-year leveraged finance issuance in Europe hit new heights in 2021. Can this pace be maintained in the months ahead? Based on pipeline activity and investor appetite for growth, the answer seems to be: Yes.
European leveraged loan issuance for M&A (excl. buyouts) climbed 19% year-on-year, reaching €54.9 billion in 2021
High yield bond issuance for deals jumped to €17.8 billion in 2021, a 53% gain on 2020
European M&A deal value came in at US$1.3 trillion in 2021—just shy of the record set in 2007 (US$1.4 billion)
A rebound in European corporate transactions has driven a double-digit acceleration in leveraged finance earmarked for M&A (excl. buyouts), with a robust pipeline setting the stage for an active 2022.
In the summer of 2021, many businesses put their house on the market, so to speak, in some cases having hesitated for years. COVID-19 had already hit pause on many M&A plans in 2020 so, when corporates that had held off selling realised that their competitors were being more bullish and attracting good prices, they jumped in with both feet.
Mega-transactions played a significant role in this rising tide of activity, such as the €24.8 billion merger between German real estate groups Vonovia and Deutsche Wohnen. Big inbound plays for European assets by US buyers were also on the menu, including Parker Hannifin’s €8.4 billion take-private of UK aerospace and defence group Meggitt, whetting investor appetite for big-ticket European corporate M&A.
At the same time, lenders were in a better position to assess the resilience of businesses after 18 months of the pandemic and were looking for a home. They had a greater degree of comfort identifying the right credits and put their money to work.
There was also an opportunistic element at play in this uptick in deals. Companies that had done unexpectedly well during the pandemic or sectors that were inundated with new business became attractive targets. Logistics companies and warehousing firms found themselves at the frontlines as more people shopped online and delivery became an essential service. Pharma companies, from vaccines to testing operations, were suddenly in the spotlight.
These factors—a backlog of deal-making coupled with a pent-up supply of credit, intriguing targets in a range of sectors, a better sense of the impact of the ongoing pandemic on these businesses and good prices being achieved—meant that the situation was ripe for a surge in deals.
According to Mergermarket data, Western European M&A deal value to the end of Q3 2021 was already higher than the annual total of any year since the global financial crisis. By the end of 2021, it had reached US$1.3 trillion—far surpassing the US$768.3 billion in deals secured in 2020 and within reach of the all-time high-water mark of US$1.4 billion recorded at the peak of the market in 2007.
This spike in deal activity has spurred year-on-year growth in both leveraged loan and high yield bond issuance for M&A, as corporates took advantage of a range of options to finance the flurry of strategic activity.
In Western and Southern European leveraged loan markets, issuance for M&A loans (excl. buyouts) climbed by 19% year-on-year, reaching €54.9 billion in 2021. And much of that activity took place towards the end of the year: July, August and September 2021 were three of the four biggest months for non-buyout M&A loan issuance.
High yield bond financing for corporate M&A (excl. buyouts), meanwhile, followed a similar upward trajectory in the region, reaching €17.8 billion for the year—up 53% on 2020.
Many sellers hitting the markets at the time were still doing so cautiously, hoping to avoid entering an overcrowded market with a limited number of increasingly selective investors. A company considering a massive deal did not want to miss out on potential investors. Timing was and is everything.
Second half surge
Issuance linked to M&A activity picked up where the high volume of refinancing activity left off, keeping the market ticking over at a healthy clip to the end of the year. Borrowers came to market early in 2021 to pre-emptively refinance existing credits at the low prices available in the market.
With loan and bond pricing moving higher as the year progressed, however, appetite for refinancing ebbed. The fact that many borrowers had already done their business earlier in the year was a further contributor to this slowdown in demand.
M&A activity was an inevitable next step for companies seeking to divest, streamline their portfolios and focus on their core business. This benefitted M&A issuers that were able to gain more traction among syndicating banks and investors that had the bandwidth to consider new money opportunities.
Spain’s fourth-largest telecoms operator MÁSMÓVIL, for example, raised in excess of €2 billion from high yield bond markets to fund the acquisition of Basque rival Euskaltel, while pan-European healthcare group Cerba inked a €500 million package of secured and unsecured bonds to fund the purchase of clinical testing laboratory Lifebrain in October. French auto components supplier Faurecia, meanwhile, issued a five-year €1 billion sustainability-linked bond to fund its €6.7 billion purchase of German peer Hella.
While corporates upped their M&A activity in 2021, strategic buyers remain somewhat cautious—many have not yet ventured to market. According to S&P Global, cash and other liquid instruments held by corporates globally climbed to a record US$6.84 trillion in 2021—45% higher than the pre-pandemic five-year average.1
Concerns around rising US and European COVID-19 case numbers due to the Omicron variant have seen corporates hang on to cash reserves, shielding themselves in the event of another round of restrictions.
At the same time, any rise in interest rates will be scrutinised by buyers and lenders alike, as it could impact deal activity significantly. If inflation continues to put pressure on margins and rates rise through the year, this burst of M&A activity may be dampened by the end of 2022.
These are valid concerns and shareholders have been patient so far, but corporates will not be able to sit on cash piles indefinitely. In addition to dividends and share buybacks, M&A will remain a key tool for deploying excess liquidity.
After a burst of activity in 2021, expect M&A markets to remain busy for the first half of the year at least, providing lenders with a strong pipeline of opportunities well into 2022.