February’s pause in European primary issuance for both leveraged loans and high-yield bonds means volumes across the leveraged finance market for the first quarter of this year will finish well down on the same period in 2021. This state of play is some distance from predictions made at the start of the year, but after news of at least one privately syndicated loan—and some signs of stability emerging across secondary markets—participants are hopeful that a full return of primary supply will follow by April.
Indeed, for those that hoped a technically strong loan market would continue to support record volumes in 2022, the data towards the end of the first quarter makes disappointing reading. For sure, there was a strong start in January—with total European loan volume of €12.8 billion notched up in that month—but supply slumped to just €5 billion in February, with no public launches yet recorded in March.
This declining issuance leaves the volume tally for the first quarter at just €17.8 billion, which is way behind the €41.2 billion recorded for the same time-frame in 2021, and means the period is the slowest opening quarter of the year since 2016. “The shock from Russia’s invasion of Ukraine and instability across markets made it impossible to price anything,” said one banker. For example, as markets first sunk at the start of the conflict, Veonet postponed syndication of its €795 million buyout term loan at the end of February, leaving the €410 million loan from ARMOR IIMAK as the last public deal to close in Europe.
Worsening tone
The tone in the European loan market had already started to deteriorate from early February—firstly due to contagion from high-yield, which was repricing after the hawkish turn from central banks regarding interest rates, and then from the darkening geopolitical situation. The effects were clearly seen in secondary with the average bid in the S&P European Leveraged Loan Index (ELLI) falling from 99.02 on Jan. 18 to quickly breach the 99 level for the first time since November 2018, and sitting at a low of 96.12 by the close on March 15. These is the lowest such quote recorded since late 2020 when the market was still recovering from its COVID-19-induced falls. Indeed, before the pandemic hit, the market had not seen these types of sub-97 quotes in the ELLI since July 2016.
While relentless, the secondary slump was not smooth and the market saw some particularly difficult days through March. Managers did continue to dip back into the market, though liquidity dried up completely on a few trading days as buyers stepped back, leaving the market offer-only. “It was like trying to catch a falling knife,” said one manager.
Returns in the Index also turned negative in February, with the ELLI recording the largest monthly decline since the COVID-19 crash in March 2020, at negative 1.11% (excluding currency). Prior to this, a negative return of this quantum had not been seen since February 2016. As of March 11, the month-to-date (ex-currency) return stood at negative 1.06%.
But as bad as these figures may be—especially in the context of the solid 4%-area returns seen in 2021—there has been little evidence of major selling from core leveraged finance investors throughout the volatility. “Nobody wants to repeat the mistakes of the COVID-19 crash when there was some large selling at big discounts that then recovered quickly,” said one manager. Another agreed, noting that illiquidity was often the major problem. “Bid-offer spreads have widened considerably and it can be very difficult to sell—or buy—anything beyond the smallest trade,” he said. Loans also held up well against high yield, which had already been under pressure in the run up to the crisis from the prospect of rising rates. “Loans still offer a solid 4% yield, so there is a question of what to buy if you sell,” said one manager.
Portfolio analysis
So rather than heading towards the exit, managers have focused on portfolio analysis. In the first instance, this process involved looking for specific Russian or Ukrainian risk, before moving towards the second-round effects of the ongoing crisis. For the former criteria, as a primarily western European-orientated market, actual Russian exposure in the leveraged space is generally limited, beyond a few names. These include Swedish bedmaker Hilding Anders (which also controls Russia’s largest bedmaker), German pharma group Stada (which said Russia accounted for roughly 14% of its sales in 2021), and British vitamin and health food retailer Holland & Barrett (which is backed by a Russian-linked sponsor).
However, exposure to second-round effects from higher energy prices or other raw-material shortages is considerably greater, and covers names as varied as Flora/Upfield, a spreads group exposed to rising agriculture prices; Klöckner Pentaplast, a plastic films group; Tarkett, a flooring group; and Keter, a maker of resin-based garden furniture. All these names have come under pressure in secondary in March, to varying degrees. “I think most managers are in the same position and have now completed their initial analysis, but there is still considerable attention on the portfolio and questions from management and investors,” said one account source.
There is also cash to put to work in the market as CLOs have continued to print deals, and while triple-A spreads have widened the move is so far relatively modest.
Napier Park printed its latest vehicle on March 11, followed by Chenavari on March 16, and both came with a triple-A tranche at 105 bps. This compares with triple-A prints of 96 bps and 100 bps achieved by Blackstone and CVC, respectively, in early March. There has been more pressure further down the stack, but single-Bs are holding at discount margins of roughly 1,500 bps, and managers maintain the arbitrage calculation still works—though equity returns could be threatened if the cost moves up much further.
Stepping out
Against this backdrop, IVC Evidensia stepped out on March 10 when it allocated a €480 million incremental term loan B6 due February 2026 to prepay revolver drawings to a small group of relationship lenders.
IVC is the largest veterinary practice in Europe, and is therefore insulated from both the crisis in Ukraine and its second-round effects. Even so, given the change in secondary the deal paid a premium to the firm’s existing stack, with a starting margin at E+475 against a TLB-4 at E+375 and a TLB-5 at E+400. The OID was not disclosed, but according to sources away from the deal the loan was last heard to be guided at 97.5, which suggests a rough yield of 5.3%.
According to LCD data, average margins and yields for single-B euro-denominated TLBs stood at 404 bps and 4.21%, respectively, in the three months to the end of January, rising to 411 bps and 4.34% in the three months to February (although this is still down from the 423 bps and 4.45% readings observed at the end of the last quarter of 2021). ARMOR IIMAK, meanwhile, priced its deal at E+500 with a 0% floor offered at 98.
Bankers and investors agree that these are the types of yields needed to tempt accounts into new transactions, through both margin and OID. “New issues will need to offer enough convexity to take into account that the ELLI is now trading in a 96 context,” said one banker.
Now IVC has demonstrated that the market is open, others are predicted to follow. This is expected to be on a private limited basis initially, with a wider syndication then predicated on the continuation of a more stable backdrop. “Conditions have been more constructive over the past few days and if that continues we may see a full market deal,” said one banker.
A bigger problem may come on the borrower side, given the market is likely to be primarily open to those names completely insulated from the crisis. “I just don’t see that many companies without an immediate need paying the yields required,” said one investor, adding that the price would probably be even higher in bonds. Sources note that IVC had been out to early birds before the invasion of Ukraine, meaning discussions in this case were already advanced once the market stepped down.
For their part, banks too are under little pressure to bring underwritten deals, given their slates are relatively clear—beyond a few big positions such as Morrisons. “The message across the market is the same, which is that books are light and no one is in any hurry to move,” said a banker, adding that even when primary reopens, flows are likely to remain light until Easter at the earliest.
Featured image by Shutterstock
Learn about our editorial standards.
