Ten years on: The surprising resilience of European leveraged finance
The European leveraged finance market paused for breath in 2018 after two feverish years, but a combination of new money issuances for LBOs and the rise of CLOs has kept the market stable
A boom in M&A activity over the past three years has boosted the market, with the volume of leveraged buyouts (LBOs) reaching levels seen pre-crisis—alongside the debt needed to fund the deals.
Investors, far from eschewing the riskier end of the lending spectrum, have been tempted up the yield curve, seeking out higher returns than those on offer in safer markets where quantitative easing has depressed yields. Encouraged by investors' desire for yield, riskier issuers/borrowers have started to demand looser terms on loans, knowing that investors, needing to deploy capital in competitive markets for deal allocations, would be more likely to accept.
For the moment, leveraged loans are in the ascendancy over high yield bonds, but large M&A deals in 2018 needed both sets of instruments to get across the line, with high yield bonds often required for that extra layer of debt. In addition, the continued growth of direct lending helped to provide financing packages that may not have been available in the syndicated or high yield markets. All the while, a backdrop of infrequent corporate defaults—assisted by low base rates—has comforted markets. Some pushback on pricing by investors was met by issuers, then reversed as the need for yield rebounded. In particular this year, investors have welcomed the return of syndicated debt instruments—2018 was a record year for collateralised loan obligations (CLO), with CLO markets breaking new issuance records in both the United States and Europe.
But if the leveraged debt markets have thrived in the post-crisis era, there are tough obstacles ahead. Geopolitical issues such as Brexit; global trade wars; Italian sovereign debt; volatility in the stock market; and a concern that default rates, low for so long, might begin to trend upwards have given the market pause. Underpinning everything is the US Federal Reserve, which is already leading the way in raising interest rates. The impact of increased borrowing costs is set to echo further afield—and could push other central banks to keep pace or react to the impact it causes.
However, despite uncertainty about what lies ahead, the market remains resilient and deals are still getting done. Ten years on from the darkest days of the crisis, the leveraged debt market has proven surprisingly resilient, but bumps may lie on the road ahead.
A decade on from the onset of the financial crisis, the leveraged debt landscape is almost unrecognisable and continues to evolve as lenders, borrowers and advisers find new ways to come to market
• In Europe, leveraged loan issuance is down 28 per cent year-on-year to €202.5 billion in 2018, but is up on all years between 2014 and 2016 • High yield bond issuance is down 37 per cent year-on-year • Leveraged loans retain primacy over high yield bonds
• European loans backing LBOs are valued at €56.5 billion, up 37 per cent from last year • Cov‑lite deals dominate the loan market, with the share of cov-lite institutional loans standing at 81 per cent in 2018 • CLOs are driving the demand for the asset class, with a new post-crisis record of €27.2 billion of new issuance and a further €18 billion of reset/refinance issuance in 2018
White & Case partners Colin Chang and Jeremy Duffy discuss how the European leveraged finance market has changed over the past 12 months and what lies ahead for 2019