European leveraged finance: from survival to prosperity | White & Case srl
The leveraged loan and high yield bond markets in Western and Southern Europe have seen a major resurgence over the past 12 months, driven initially by refinancing, followed by M&A issuances and near-seamless buyouts. previous year, and setting the stage for an overall productive year ahead
Like our latest leveraged financial report reveals, the first quarter of 2022 finds the European leveraged finance market relatively well positioned, driven by the momentum that began in early 2021.
In 2021, issuance of leveraged loans and high yield bonds in Western and Southern Europe reached the highest annual total value ever seen on By debts registration. Leveraged lending in the region fell from $259.6 billion to US$343.3 billion year-on-year, while high yield bond markets were even more enthusiastic, with issues for the year rising from US$113 billion in 2020 to US$175.9 billion in 2021.
Global issue in value 2015 – 2021
Device type: Leveraged loans Use of profits: All
Site: Western and Southern Europe Sectors: All sectors
Many lenders and borrowers have clearly shifted from survival strategies to growth strategies over the past 12 months, but can this pace continue?
Behind the growth
There are obvious drivers behind this record increase in activity. First, low interest rates and prices, coupled with rumors of future interest rate hikes in Europe, triggered a wave of refinancing in the first half of the year.
Issuers in the region locked in lower rates as the average pricing for prorated debt and institutional loans fell from over 4% in Q4 2020 to less than 4% at the end of Q2 2021. The The high yield market followed a broadly similar trend as T1 and T2 pricing fell below the 4% threshold.
Leveraged loans for refinancing, repricing and amendments achieved US$160.1 billion in 2021 (up 74% year-on-year), while high-yield bond issuance for this purpose increased by 34% over the same period, reaching US$101.5 billion.
Refinancing issue slowed down in the second half as prices started to climb, but they still accounted for half of the global leveraged finance issuance at the end of 2021.
As refinancing slowed, M&A activity surged, driven by pent-up demand, excess capital and attractive pricing. According to Merger market data, Western Europe M&A deal value reached $1,319 billion in 2021, approaching the all-time high of US$1.364 billion recorded in 2007.
Mega-deals have played a big role, from the €24.8 billion merger between German property groups Vonovia and Deutsche Wohnen to Parker Hannifin’s €8.4 billion privatization of the British aerospace group and defense Meggitt, whetting investors’ appetite for big-money European corporate mergers and acquisitions.
Buyout activity also took off during the year as a large private equity (PE) dry powder was finally released. European exit and redemption value reached US$613.2 billion in 2021 – the highest annual total Merger market registration.
Buyers hit the market aggressively, better prepared to assess whether a potential target was likely to struggle or grow after operating for more than a year in pandemic conditions.
As a result, buyout loan issuance in Western and Southern Europe jumped more than 80% year-on-year to US$78.6 billion in 2021, with provision for high yield bond buybacks over the same period increasing from US$7.9 billion to US$18.3 billion.
The debt bundles that will be needed to fund the current pipeline of takeovers – from the £10bn takeover by Clayton, Dubilier & Rice of supermarket chain Morrisons to KKR’s €33bn bid for Telecom Italia (if these materialize) – will keep lenders busy in 2022.
Challenges on the horizon
Despite these positive signs, there are still reasons to be cautious.
First, we are not out of the COVID-19 wood yet. The Omicron variant appears to be less damaging than earlier waves of the pandemic, but any hint of new restrictions may force some companies to hold onto stockpiles, especially if they struggled in previous waves of the pandemic.
Second, inflation continues to climb and rising interest rates are a real concern. The UK got the ball rolling with its first interest rate hike in three years in December 2021, followed by a second hike two months later. It now stands at 0.5% and this will probably not be the last increase this year.
The EU may well follow suit in 2022, despite protests from the European Central Bank. In November 2021, the President of the European Central Bank, Christine Lagarde, insisted that “the conditions for raising rates are very unlikely to be met next year”. In February 2022, she refused to rule out a rate hike in 2022, stating that “the situation has indeed changed”.
As debt becomes more expensive, decisions about mergers and acquisitions and takeovers, as well as their financing, become more complicated. Some may take a break while others – from companies in good financial health to private equity firms with cash to spend – may decide to invest in a post-COVID-19 future.
Third, supply chain disruptions are always on everyone’s radar. These could be temporary bottlenecks, caused by an increase in demand as COVID-19 restrictions were lifted, but they can also be a red flag for lenders in the months leading up to a transaction. . Any issues can increase business costs, cause delays, and lengthen delivery times, which can drive customers away.
Supply chain risk and its potential impact on credit quality will likely feature in any assessment of borrower exposure. So do global shortages of raw materials, from carbon dioxide to oil, and critical components like semiconductor chips and labor shortages in logistics and transportation.
Borrowers may need to review their supply chain, from finding more local options to building inventory to stabilize prices until bottlenecks are resolved.
Finally, environmental, social and corporate governance (ESG) criteria remain highly relevant. Benchmarks launched in 2022, such as the EU Sustainable Financial Disclosure Regulation, are already making waves.
The European CLO market, in particular, has taken notice. ESG objectives are rapidly converging, giving CLOs access to large and growing pools of capital for ESG-related investments. As a result, new CLO issuance in Europe reached €38.5 billion at the end of 2021, up 75% year-on-year and peaking in November 2021 at €6.3 billion, its highest level on By debts registration.
What does this mean for the year ahead?
Over the next 12 months, lenders sitting on large pools of capital and chasing returns could stretch their nets even further, backing good, lower-rated credits to secure returns despite the risks. The process has already begun: B-rated credits accounted for a larger share of overall issuance in 2021 than in 2020.
At the same time, credit quality will influence terms and documentation. In 2021, there has been an increase in the number of flexible margins in syndication processes. Flexibility will remain the order of the day when it comes to popular credit documentation. But, if there is an increase in lower-rated credits in the market, then lenders’ and sponsors’ opinions on their quality will decide the terms and prices available. Market participants are likely to be more cautious when it comes to more risky trades. Pragmatic mid-level sponsors may accept tighter documents and higher prices to close deals.