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.
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?
Stay current on your favorite topics
HEADLINES
By all accounts, leveraged finance markets in the United States were hot in the first quarter of 2021. This activity was driven primarily by refinancing and repricing. Borrowers jumped at the chance to take advantage of the favorable terms and pricing to refinance existing loans and bonds at lower margins and extend maturities. Recent high-profile refinancings include a US$5 billion term loan B maturing in 2028 by United Airlines and a US$1 billion term loan B refinancing by WW International, also maturing in 2028.
60%
The rise in leveraged loan issuance in H1 2021, year-on-year
The market's pace cooled slightly in the second quarter, but the fundamentals still point to a positive second half, with strong investor demand supporting sustained levels of activity as the economy begins to open up.
Leveraged loan issuance to the end of June 2021 climbed to US$763.5 billion, up 60 percent from US$478.1 billion over the same period in 2020.
Institutional loans, i.e., the portions (tranches) of a loan that are structured/sold to non-banks, such as funds, pensions and insurance companies, have seen an even sharper rise. Issuance climbed from US$288.7 billion in 2020 to US$520.4 billion year-on-year, supported by investor demand.
Issuance in the high yield bond market is also up for the period, climbing 22 percent from US$219.6 billion a year ago to US$267.1 billion over the first six months of 2021.
Refinancing and repricing deals in US loan markets reached US$471.7 billion by the end of June 2021 and accounted for 62 percent of overall loan issuance in that period. Refinancing and repricing expanded even faster in the institutional loan market—up 92 percent on the same period in 2020, reaching US$329.7 billion and accounting for 63 percent of total institutional issuance.
In the high yield bond market, refinancing represented 70 percent of overall activity, with issuance for that purpose reaching US$186.8 billion, up 48 percent on the same period the previous year. For example, telecoms operator T-Mobile US refinanced a cluster of senior unsecured bonds with a combined value of US$3 billion and prices ranging from between 2.25 percent and 3.5 percent.
Although year-to-date issuance figures have recovered strongly from levels observed a year ago—when COVID-19 sent the market into a temporary shutdown—borrowers, lenders and investors pumped the brakes somewhat in the second quarter of 2021.
Leveraged loan issuance for April slid 16 percent from March levels to US$147.2 billion, with month-on-month high yield bond activity down 13 percent between March and April at US$50.7 billion. The April slowdown came as the frantic pace of refinancing tailed off. Loan refinancings and repricings eased from US$122.9 billion in March to US$88.7 billion in April, while high yield bond refinancing was down from US$48.5 billion in March to US$31.6 billion in April.
This cooling off period in refinancings and repricings, however, was countered by a welcome uptick in new money deals, with an especially notable improvement in new money issuance in the institutional loan space.
The US$147.4 billion in new money issuance in the leveraged loan space in Q2 2021 was up 42 percent on the previous quarter's US$104 billion total and a big part of the 36 percent year-on-year uplift in new money activity to US$251.3 billion.
In the high yield market, new money issuance of US$50.7 billion in Q2 2021 was almost double the US$26 billion seen in Q1.
In the institutional loan space, the proportion of lending allocated to new money deals—US$161.5 billion—stood at 31 percent for H1 2021, though it was approximately 50 percent for much of Q2 according to Debtwire Par.
Consistent rises in institutional loan issuance for M&A (excluding buyouts) and LBO deals—finishing the half year at US$71.2 billion and US$50.2 billion respectively—have been particularly encouraging after a period of relative scarcity for new M&A and LBO deals during the first quarter of the year.
High yield bond markets also enjoyed increased activity due to M&A and LBO deals, with issuance for these purposes reaching US$30 billion and US$8.4 billion in H1 2021, respectively. Issuance for both purposes reached record heights in Q2 2021, with US$22.9 billion allocated to M&A activity and US$6.9 billion issued for LBOs—in both cases, this was the highest quarter on record going back to 2015.
Significant LBO deals in the US this year included CoreLogic, a California-based property data analytics business, which locked in US$4.5 billion in leveraged loans and a US$750 million high yield bond to fund its take-private buyout by PE firms Insight Partners and Stone Point Capital. In the high yield market, the Michaels Companies—an arts and crafts retailer that sells through its Michaels chain of stores—issued US$2.15 billion in high yield notes to support its takeover by buyout investor Apollo Global Management.
RealPage, another property software business, was also in the market with a US$4 billion leveraged loan to fund its acquisition by buyout house Thoma Bravo.
The calmer market in Q2, coupled with the rise in new money deals, also gave lenders and investors the space to take a firmer position on pricing.
High investor demand in Q1 2021 gave borrowers the opportunity to negotiate tighter pricing and push out maturities, which saw the weighted average margins on first-lien institutional loans recorded at 3.46 percent over LIBOR in Q1 this year, down from 4.17 percent over LIBOR in Q4 2020 according to Debtwire Par.
By the end of the second quarter, however, the average margin on first-lien institutional term loans edged back up to 3.61 percent. In addition, original issue discounts (OIDs)—the discount from par value at which a loan is sold—widened in favor of investors. Average OID discounts of 99.65 percent (35 bps discount) in Q1 widened to 99.35 percent (65 bps discount) by the end of June. This has seen average yields on loans increase from 4.21 percent at the end of Q1 to 4.55 percent at the end of Q2 2021.
High yield bond yields edged lower in the first half of the year. The weighted average yield to maturity on senior secured high yield bonds narrowed from 5.97 percent in Q1 2021 to 5.36 percent in Q2 2021. For senior unsecured high yield bonds, pricing moved from 4.77 percent for Q1 2021 to 4.66 percent for Q2 2021.
This change in pricing dynamics prompted more borrowers to reset their pricing expectations. Debtwire Par tracked 14 borrowers in April 2021 that agreed to pricing wider than initial indications—the highest level observed this year. One Call, for example, secured a US$700 million first-lien term loan priced at LIBOR +5.5 percent with a 98 percent OID, after initially going to market with plans to raise a loan package of US$850 million with a 99 percent OID and pricing range of LIBOR +4.75 percent-5 percent.
Despite the slight dip in activity, the outlook remains positive for the second half of the year. Investor demand remains strong, with CLOs active and retail investors showing appetite for loans.
CLO issuance of US$80.5 billion for the year to the end of June is up 140 percent year-on-year and Lipper reports that loan exchange traded funds and loan mutual funds are attracting incoming funds after a period of outflows.
In the secondary leveraged loan market, meanwhile, pricing has stabilized. Debtwire Par figures show that, at the end of June, 24 percent of loans in the secondary market were trading above par (having climbed as high as 44 percent earlier this year), with 47 percent of the market trading in the 99 percent to par pricing range.
Credit quality has also improved. In June, ratings agency Fitch forecast that US leveraged loan and high yield bond defaults were on track to hit ten-year lows. Fitch reduced its leveraged loan and high yield bond default rates forecasts for 2021 from 2.5 percent and 2 percent to 1.5 percent and 1 percent, respectively. Credit rating actions have been moving in the right direction too—in the last two weeks of June, out of the 153 actions taken for 137 companies in North America, 60 percent were changed to "stable" and 12 percent were revised to "positive" while just 6 percent were changed to "negative" ratings.
President Joe Biden is also expected to influence loan and bond market regulation and trends in the months ahead. For example, he appointed Janet Yellen as Treasury Secretary. Separately, Maxine Waters regained the chair of the House Financial Services Committee. These two people could prove significant.
Yellen, who was Federal Reserve Governor in 2013 when government agencies issued guidance to limit leverage multiples at 6x EBITDA, has long been hawkish about the amount of leverage in the system, especially when carried by borrowers that are not investment-grade issuers. She has also considered increased regulatory oversight of non-bank direct lenders, which could shift the dynamics for borrowers.
Waters, meanwhile, has been a long-time supporter of a policy to cap leverage levels at 6x EBITDA and, alongside Yellen, was a vocal opponent of the decision to loosen rules and allow banks to back debt funds. Both figures will want to see leveraged finance markets regulated more closely during their terms.
The Biden administration has also made the fight against climate change a central policy objective, the impact of which should not be underestimated in leveraged loan and bond markets. The President's focus on climate change and other environmental, social and governance (ESG) objectives has contributed to a surge in the issuance of green bonds, sustainability-linked debt instruments, and leveraged loans and bonds that include ESG ratchets, which shift margins on loans up or down depending on compliance with pre-agreed ESG criteria.
The inclusion of ESG clauses in debt documentation is expected to continue to gain traction, as borrowers, banks and investors move ESG up on the list of priorities.
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
View full image 'US leveraged loan versus high yield bond quarterly issuance (H1 2021)'(PDF)
View full image 'US institutional loan pricing (2017-H1 2021)' PDF
View full image 'New issue high-yield bond (2017-H1 2021)' PDF
View full image 'Original issue discounts (OID)* (2017-H1 2021)' PDF
View full image 'US CLO volume, quarterly new issue versus re-issue (2018-H1 2021)'PDF
View full image 'US covenant-lite share of institutional loans (2013−H1 2021)' PDF
