HEADLINES

• 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

European leveraged finance markets have been completely reconfigured in the past 12 months. Inflation, rising interest rates and geopolitical uncertainty have squeezed liquidity and seen high yield bond and leveraged loan issuance decline as borrowing costs have climbed.

The wave of prolific refinancings secured in the hot market of 2021 has run its course and M&A-linked issuance has also fallen away as dealmakers pushed the pause button to assess the impact of macro-economic headwinds on deal targets.

What does this mean for borrowers and lenders in the next 12 months? Here are five key trends that we think will drive activity in the market in 2023.

1. Amend-and-extend (A&E) arrangements will increase

As leveraged finance markets have tightened, borrowers have no longer been able to rely on refinancing to push out loan and bond maturity walls or secure capital on more favourable terms.

With refinancing effectively off the table, borrowers with credits approaching maturity will look to A&E their existing debt tranches with amendment and extend deals and/or exchange offers. These deals will offer lenders a consent fee and a higher coupon in exchange for extending loan maturities by 12 to 24 months. Borrowers will also bring lenders onboard by putting equity injections, deleveraging, more covenant protections and/or additional credit support on the table. While common in the loan world, this trend likely will expand into the bond market as shorter-term extensions balance both immediate maturity concerns but also investor concerns over long-term commitments in an uncertain market.

In Q4 2022, German generic drug manufacturer Stada and UK consumer credit group NewDay were among the first high-profile bond credits to make A&E offers to lenders. Spanish paper manufacturer Lecta also turned to A&E during the same period, confirming that it had received consent from lenders to amend-and-extend its €115 million senior facility agreement.

Debtwire Par's inaugural mid-market survey, conducted in Q4 2022, confirms this trend is likely to continue in the months ahead. According to the survey, 32 per cent of respondents say they expect to see more A&E mitigation strategies employed in the next three to six months, second only to covenant waivers.

Expect more A&E to follow suit in 2023.

2. Pause in mega-market deals will open the door for mid-market financing to dominate

Inertia in syndicated loan and high yield bond markets has made it challenging for mega-market private equity (PE) firms to finance jumbo deals, which has seen a decline in big-ticket M&A value. Mid-market M&A, however, is proving more resilient.

According to data from Mergermarket, mid-market M&A deal value in Western Europe (deal valuations in the US$5 million to US$999 million range) slid by 13 per cent year-on-year in 2022, whereas deal value for US$1 billion+ transactions was a third off 2021 levels.

With capital markets expected to remain difficult to access for a time, mid-market M&A financing—which is currently predominantly provided by direct lenders that still have large dry powder cash piles to deploy—is set to remain available and help to sustain mid-market deal volumes. With the opening of a new year, banks are also expected to become more active in these markets.

With megadeals on hold for now, large-cap financial sponsors will be more likely to pursue smaller transactions, providing an additional boost for mid-market financing demand.

Dealmakers and lenders will also remain open to pursuing and financing public-to-private deals, an area that has remained active for M&A due to currency fluctuations and lower stock market valuations.

3. Secondary markets will determine primary market prospects

European primary leveraged finance markets will only reopen on attractive terms when secondary markets improve.

As macro-economic headwinds intensified through 2022, European debt traded at ever deeper discounts. According to Debtwire Par, European leveraged loans were pricing at an 11 per cent discount to face value in secondary markets in September and October. This compares to discounts of less than 2 per cent at the start of the year.

Until discounts narrow, the prospects of a rebound in primary markets will be slim and will only be used where necessary or opportunistically for the right deals. So long as credits trade well below par, secondary market trades will remain significantly more attractive than refinancing opportunities and new money deals—even when issuers are prepared to offer wide original issue discounts. Spreads will have to narrow to incentivise lenders to get back into the game on the primary side.

4. Restructurings loom on the horizon

While it may be the main option of choice as described above, A&E will not be an option for all borrowers—lenders will favour credits that are performing well in stable sectors and demand generous sweeteners if A&E transactions are to proceed. Certain CLO investors, meanwhile, may not be able to extend maturities as their weighted average tests may restrict them from rolling debt. Meanwhile, PE firms will only invest resources in A&E deals if they believe portfolio companies have realistic prospects of returning to growth in the medium to long term.

Covenant-lite debt packages will provide credits that are under pressure with some breathing room, but this may just mask problems, leading to harsher restructurings in the future when maturities approach and cash balances run low.

Distressed debt funds, meanwhile, are marshalling new pools of capital and buying up discounted debt in anticipation of more distress and special situations where money can be put to work.

5. Sponsors will hold ground on terms

PE firms may find it more difficult and more expensive to source debt in 2023, but there are no signs of any major evolution in terms and documentation.

Cov-lite structures and flexible terms have become embedded in the market. Pragmatism will be prevalent on deals as key points of focus reach a compromise—but, with the penalty of increased borrowing costs, this will likely be seen as compensation enough, rather than the market turning back to old school documentation.

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