European leveraged loans have taken a back seat to a high-yield-heavy issuance calendar since the Easter break, but despite no more than gentle supply and a light pipeline, there is evidence of deepening loan demand.
The relatively heavy rush of bond launches that started in mid-April came amid a wide reopening of the issuance window after the banking-sector-led disruption seen in March. Indeed, during that flurry six European bonds priced for a total of €2.3 billion, the busiest week since late January. “I think there is a sense that banks want to push as much out as they can from Easter through to May, in case that month lives up to its reputation,” said one manager, referring to the maxim that May can be a difficult month that sees sellers emerge.
The return of issuance after yet another period of disruption has also handed the technical advantage to bonds. “I don’t think there is a huge amount in it, but if issuers had a choice right now then I’d recommend they go to bonds over a loan,” said a banker.
In a Barclays research note published April 14, analysts led by Craig Nicol pointed out that the overall size of the European high-yield market has declined by more than €50 billion since January 2022, as borrowers exited indices through repayments or credit-rating upgrades in a low-issuance environment. This is the largest such shrinkage on record, and its scale means accounts are now highly receptive to issuance when it comes, sources note.
Volume dial
In contrast, new issuance in loans has been steady — if unspectacular — all year. The market was largely able to brush off last month’s volatility, with only modest weakness in secondary and some adjustment in primary pricing that has now been reversed.
LCD data shows that loan volume for the year to April 21 is running at €14.5 billion, down from €22.5 billion in the same period last year. Last year though, the market had come to a near halt due to Russia’s invasion of Ukraine, and the gap to the previous year is even starker — total loan volume was €41.2 billion in the first quarter of 2021. Meanwhile, the average bid in the Morningstar European Loan Index (ELLI) has risen back to around 94, after dipping to 93 toward the end of March.
The main reason for the collapse in loan volume is clear — Europe started the year with virtually no pipeline, and there has been little in the way of M&A supply since. Buyout volume for the year to April 21 totals just €2.1 billion, down from €9.7 billion in the same period last year. The one sizeable deal left hanging was the €2.9 billion-equivalent financing backing the Advent and Lanxess joint venture’s buyout of DSM’s Engineering Materials business to create Envalior. In the event, this deal closed without a full-scale syndication to a mix of private debt funds, bank lenders and CLOs, sources explain.
This dynamic left refinancings via extensions and add-ons dominating the market, which have in general been positively received. On April 21, Action closed its 3.5-year extension, upsized from a minimum of €1.5 billion to €2.5 billion, and at the tighter end of talk of E+375 offered at 98.5. The BB-/Ba3 rated deal also gained strongly on the break to bracket par.
“There is clear demand for loans,” said an investor at the end of April. Also on April 21, the €446 million term loan backing Towerbrook’s buyout of French cleaning services firm GSF closed tight of talk at E+500 offered at 94, and opened higher on the break in a 96.375/97.625 market. The GSF buyout was underwritten last year, but now this deal and DSM are cleared, bankers say there are few other situations hanging (although some paper is still sitting on balance sheets from TLAs or unsold portions of TLBs). Also last week, KronosNet wrapped a roughly €158 million TLB add-on to reduce a TLA carved out from a merger facility allocated last September.
Against this backdrop, Europe’s extension and add-on led market looks set to continue. For now, the longest extension has stretched to September 2028, and while demand is there for a straight seven-year refinancing for a credit like Action, the market is unlikely to see a return of these deals soon. “The view is CLOs would prefer to conserve WAL with several shorter extensions rather than a smaller number of seven-year transactions,” a banker said. Another agreed, noting that a 2.5-3.5-year extension is the most cost-effective and efficient route for sponsors seeking extra runway for a sale or longer-term financing.
Mind the gap
Indeed, the year’s extension and add-on activity has brought clarity to the “new world” pricing requirements of today’s market. Spreads have come down since the third quarter of last year, to a generic E+475 margin along with two to three points of OID for a decent single-B credit backed by a popular sponsor, sources agree. On a rolling three-month basis to April 27, the average spread and yield to maturity for euro-denominated single-B deals reached E+493 and 8.9%, respectively, according to LCD — up slightly from E+489 and 8.7% at the end of the first quarter.
Pricing for a fresh buyout may require more of a premium, however. “Managers are happy to support existing credits that they like, but the cost for a marginal buyer on a new-money deal may well be higher,” cautioned one banker.
This situation opens up a gap with private credit, that had been pricing close to syndicated markets through the dislocation across much of last year. Now, managers are assuming starting private credit margins of roughly E+650 with four points of OID — and a likely covenant — meaning direct lenders are once again bringing an illiquidity premium to the syndicated market.
The syndicated market is returning to normality in other ways, and banks are again more willing to take market risk and underwrite. At the end of April, for example, it emerged that JP Morgan had provided committed financing of €1 billion to support Silver Lake’s bid to take Software AG private, in deal that values the German tech group at €2.5 billion. While details are still sketchy, the deal appears to be the first major non-dollar European buyout underwrite since the acquisition of Fedrigoni in July last year by BC Partners and Bain, which was backed by a €1.18 billion bridge to high yield taken out in October.
Even so, while there are a group of banks willing to underwrite a reasonable range of credit stories, sources agree that a larger group are notionally open, but are more likely to wait for further deal flow and data points before taking risk onto their balance sheets, while a smaller, third group are closed. “The market is there for European underwriting but it’s more concentrated today,” summed up a banker.
This still leaves more than enough capacity for sponsor needs, sources agree, adding that valuations are the bigger problem. “It’s not access to financing that’s stopping buyouts but the gap between what sellers want and what buyers are prepared to offer,” said a banker. A private equity source agreed, adding that buyers remain cautious over the economic outlook and are not prepared to meet expectations they believe are based on now-outdated assumptions. Not least of these is the cost of debt, which has still doubled in a little over a year given the rapid move in rates, with an obvious read-through to leverage and equity returns.
Supply source
In this context, the public markets could offer an alternative source of supply. In addition to Software AG, deals in contention include a £4.6 billion bid from EQT for UK veterinary medicine group Dechra Pharmaceuticals, a potential £2.1 billion bidding war for emerging markets-focused payments group Network International, a £1.7 billion offer from Apollo for Aberdeen-based energy services group Wood, and a preliminary approach from Apollo for e-commerce group THG.
But while these offers suggest the leveraged finance market could see significant supply later in the year, sources remain cautious. “People talk a lot about take-privates but they are fraught with difficulty and most don’t come to anything,” said one private equity source. For one, public shareholders — just like private equity — don’t want to sell out on the cheap. An investor in Dechra, for example, has come out against EQT’s bid, calling it opportunistic and failing to reflect the firm’s pipeline of pharma products, according to reports.
The time for take-privates to come to market meanwhile can be measured in months, and a deal agreed today is unlikely to be ready to syndicate much before the autumn. This length of market risk also means many deals under discussion — assuming an agreement can be reached — will be better targets for private credit rather than banks.
That said, the very fact these deals are under consideration points to a confidence and level of demand that simply wasn’t there for much of last year. “This was always going to be a year of two halves,” said a private equity source. “In the end, private equity needs to do deals and churn portfolio holdings, so valuations will probably end up meeting in the middle,” he added.
Featured image by Gargantiopa/Shutterstock
Learn about our editorial standards.
