HEADLINES
- Leveraged loan issuance in Western and Southern Europe reached €183.4 billion in 2022, down by 37 per cent year-on-year
- High yield bond activity was down 66 per cent during the same period, at €50 billion
- Loan margins were up by 0.64 per cent by the end of the year, while average yields to maturity for high yield bonds climbed by nearly 3 per cent
European leveraged finance markets saw significant inertia through the course of 2022 as high inflation, rising interest rates and cooling M&A activity put the brakes on leveraged loan and high yield bond issuance. How will these headwinds affect leveraged finance markets in the year ahead?
According to data from Debtwire Par, leveraged loan issuance in Western and Southern Europe was down 37 per cent in 2022, year-on-year, at €183.4 billion, with institutional loan issuance suffering an even steeper decline, down by 67 per cent at €52.9 billion. High yield bond markets in the region have seen similar slowdowns, with issuance down 66 per cent across the first ten months of 2022 at €50 billion.
The steep decline in activity came as the conflict in Ukraine dampened investor appetite for risk and central banks bumped up interest rates to keep a lid on surging inflation. This, coupled with political volatility (including multiple successive UK prime minister changes as well as the ongoing impact of Brexit), meant that markets had little positive momentum on which to rely in changing their risk assessment.
The decline in leveraged loan issuance in Western and Southern Europe in 2022, year-on-year
In the UK, with inflation reaching a 41-year high of 11.1 per cent in October, the Bank of England upped rates to 3 per cent in November and 3.5 per cent in December—the highest level since 2008. The European Central Bank also raised rates to the highest level in more than a decade by the end of 2022, with a 0.5 per cent increase announced in December to tackle inflation that is running above 9 per cent.
As interest rates have climbed, so have borrowing costs. The average margins on first-lien institutional loans were sitting at 4.02 per cent at the end of 2021 but spiked to 4.73 per cent by the end of Q4 2022. European high yield bond borrowing costs almost doubled, with the weighted average yield to maturity for fixed rate bonds up from 4.73 per cent at the end of 2021 to 8.23 per cent in Q4 2022.
Refinancing unattractive as secondary market pricing plunges
Rising borrowing costs and a recalibration of risk appetite from lenders and investors has had a chilling impact on refinancing activity, which was a major driver of activity at the end of 2020 and through 2021.
High yield refinancing deals dropped to just €19.2 billion for the year, a 77 per cent year-on-year decline, while loan refinancing volumes fell 45 per cent from €134.9 billion to €74.3 billion during the same period in 2022.
As the abundant liquidity and low debt costs dried up, and with many maturities already addressed, there has been limited scope for opportunistic borrowers to refinance existing credits on better terms and extend maturities. For lenders and investors, meanwhile, the deep discounts to par that have emerged in the secondary market have blunted the appeal of refinancings. Debtwire Par figures show that European leveraged loans priced at an 11 per cent discount to par in secondary markets in September and October, encouraging investors to pick up bargain secondary market trades rather than support refinancings.
New money deals, meanwhile, have also contracted due to discounts in the secondary market. In order to gain any kind of traction for new deals, borrowers have been forced to accept significantly deeper original issue discounts (OID). This has prompted borrowers to put financings on ice until market conditions improve—and investors still seem inclined to wait for secondary market opportunities even when deep OIDs are offered.
These factors saw new money loan issuance fall 29 per cent year-on-year to €105.3 billion, while high yield new money transactions fell 52 per cent in 2022. Falling European M&A and buyout transaction flow—down 30 per cent year-on-year by the end of 2022—has also knocked new money activity. In loan markets, M&A and buyout issuance dropped by 69 per cent and 9 per cent respectively for the year, with high yield markets also recording an 81 per cent slide in M&A issuance, with buyout issuance decreasing by 52 per cent.
Adjusting to the new normal
Moving into 2023, loan and high yield activity is likely to continue facing headwinds. There is still limited visibility on when European inflation will peak and interest rates will top out. Lenders and investors will remain cautious while issuers will avoid coming to market unless strictly necessary.
Smaller deals and add-on deal financings—such as UK online retailer THG's £156 million add-on term loan B—will still find a way through loan markets, while high yield markets will open intermittently and facilitate some issuance, as seen with deals including Hunkemoeller, Fedrigoni, EnQuest and Cirsa, which managed to secure financing in the final quarter of 2022.
Overall, the European market will remain challenging. By the end of 2022, the pipeline for deals had slowed to a trickle—Carlyle's purchase of Italian motorcycle gear company Dainese and a refinancing for the UK insurance broker Ardonagh (backed by the Abu Dhabi Investment Authority) were the only deals on the horizon.
When deals do come forward, borrowers may have to scale back their expectations. For example, in October 2022, Dutch artificial turf manufacturer TenCate Grass postponed a €274.3 million add-on to its €315 million EURIBOR+ 500 bps term loan B due September 2028 because of the volatile market conditions.
Borrowers are also expected to run dual-track financing processes more often, with direct lenders in line to pick up an increasing volume of transactions that would otherwise have gone down the high yield bond or leveraged loan route. Italian specialty food ingredients producer Irca, for example, shifted the financing for its acquisition by Advent International from The Carlyle Group from a proposed €430 million high yield bond note to a direct lending package provided by CVC Credit.
Maturity extensions front and centre
Maturities during 2023 and onwards will need to be dealt with in creative ways. Typically, both borrowers and lenders want to avoid a restructuring where possible. This is expected to drive an increase in amend-and-extend deals, both in the loan market where this is more traditional, but also in the high yield market, as seen in the exchange offer undertaken by German pharmaceutical company Stada in October 2022. These deals will see borrowers move to extend maturity walls by offering incumbent lenders higher coupons, additional covenants and/or additional credit support.
Equity injections may also become more common as sponsors see the need to support portfolio companies through a rough patch and to convince investors of long-term value in a business.
The scope for maturity extensions could be limited for certain CLO investors, as their weighted average life tests restrict their ability to roll debt. But when maturity extensions are an option, it is hoped that these arrangements will help to avoid large-scale insolvencies and full-blown restructurings in 2023, with lenders willing to accept more favourable pricing and terms in exchange for maturity extensions rather than crystallising losses.
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