Stalled issuance, growing concerns around rising costs, supply chain bottlenecks and the conflict in Ukraine—it's been a whirlwind of a year, with many remaining challenges for the year ahead

Typically, the pattern of peaks and valleys witnessed in leveraged finance since the start of the pandemic suggests we may be set for a rise in activity at some point in 2023—were it not for the various headwinds continuing to blow against potential progress.

What can markets expect to see in the year ahead?

Debt in Europe is not getting less expensive anytime soon

In December 2022, the Bank of England Monetary Policy Committee, the European Central Bank (ECB) and the US Federal Reserve all decided to increase base rates yet again. President of the ECB, Christine Lagarde, warned of more rate increases in 2023, while US Fed official John Williams added fuel to the fire by warning that the Fed's policy rate may exceed the expected 5.1 per cent level.

While the public will be worrying about mortgage payments and the cost of living, this will concern any borrower hoping to secure new debt in 2023 without paying a premium. Average margins on first-lien institutional loans peaked at 5.39 per cent in Q3 2022, before cooling to 4.73 per cent in Q4—though still much higher than the 4.09 per cent seen at the start of the year.

It's been a similar story for European high yield bond borrowing costs—the weighted average yield to maturity for fixed rate bonds climbed from 5.39 per cent in Q1 2022 to 8.23 per cent at the end of the year.

All these factors will challenge any highly leveraged borrower hoping to maintain their current standing in the market.

From A&E to add-ons

These pricing pressures paint a challenging picture for 2023. Fitch Ratings anticipates that ratings on high yield bond and leveraged loan issuers in Europe will deteriorate in the coming months. In addition, Fitch predicts that default rates could reach as high as 4 per cent in 2023 and 2024. By comparison, the institutional leveraged loan default rate finished 2021 at 0.6 per cent—the lowest rate in a decade.

Borrowers feeling the pinch will have fewer options to finance their way out of a rising debt load than they once did. Those facing maturities in the next two years are likely considering everything from amend-to-extend deals to improved covenant and/or security packages, equity injections or add-ons to push those maturity dates out further. As Debtwire Par reports, telecoms group Altice International based in Luxembourg, sports betting business Entain in the UK and French medical diagnostic firm Sebia all closed amend-and-extend deals late in 2022, targeting maturities between 2024 and 2026.

Credit quality will also be a factor for those chasing liquidity, with quality credits or those in “safe haven” sectors such as defence or infrastructure taking precedence—though that is not limited to the top end of the rating scale.

For example, per Debtwire Par, December transactions included UK nurseries operator Busy Bees (B-/B3 rating) which secured a fungible €105 million TLB add-on to repay revolver drawings, and French laboratory service provider Cerba Healthcare (B/B2), which secured a €220 million non-fungible add-on to its EURIBOR + 400 bps February 2029 TLC, priced at a margin of EURIBOR + 550 bps and a 96.5 OID. This demonstrates that transaction opportunities are not closed to mid-rated companies where supported by the market.

This flurry of activity inspires confidence at a time when investors do not know where things will land. Assets deemed safe and secure will continue to attract attention in the months ahead.

For those unable to pursue options like amend-and-extend deals or add-ons, private credit funds may also offer something of a lifeline. However, this may come with a hefty price tag. Decreased availability of bank debt means private credit margins have been climbing—Debtwire Par reports that they are up by at least 2 per cent on the start of the year.

Anyone hoping private debt will offer an escape from looming maturities may find themselves priced out in the coming months. Private investors may also worry about a company unable to secure an amend-and-extend deal, as this may flag a company in greater distress than is apparent.

Focus on the positive

The fact remains that, at the start of 2023, the economic dust of the past 12 months has not yet settled. We may hope that the worst has passed, but as we have learned through recent events, stability and consistency are not guaranteed.

When inflation began to climb, many argued that it was simply a market correction, likely due to the pandemic and rising oil prices. When the conflict began in Ukraine, many suggested that it would last a matter of weeks at most. As rates began to rise, many suggested it was only for the short term and central banks would settle down soon enough.

A year later and it's clear that factors such as these will continue to influence the market for some time to come, along with wider geopolitical and economic volatility.

One thing is clear: Choosing the right path in 2023 with be a challenge for everyone.