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Extensions dominate European loans as M&A activity sags, but returns soar

Extensions have led European loan volume through 2023, as sponsor-backed M&A deal-making stayed stubbornly subdued.

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Extensions have led European loan volume through 2023, as sponsor-backed M&A deal-making stayed stubbornly subdued. There was still plenty of action to keep managers occupied though, and loan returns are on course to end the year at a post-GFC high.

The launch last week of the €900 million term loan backing Cinven’s take-private of Synlab brings a full slug of new-money supply to a market where M&A deals have been notably absent. Indeed, LCD data shows the volume of M&A-linked loans syndicated in Europe this year — at €15.71 billion — is on track to be the lowest since the immediate aftermath of the GFC in 2009.

However, these numbers should not disguise the fact that 2023 has otherwise been a more than respectable year for loan volume. “Away from M&A, there has been plenty of paper available from amend-and-extends, add-ons and other deals to fill a portfolio,” said one manager.

Just as Synlab is not characteristic of the wider year’s market, the remainder of December’s activity is more typical, and this supply brings a slew of extensions as well as add-ons to finance such things as revolver clean-downs, dividends, tuck-in acquisitions and repayment of second-lien loans. As a share of total loan issuance, add-ons are running at a record high of 44.6% so far this year, with add-on volume also on track to close out 2023 at a European record.

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Extension lead
But it is extensions that have dominated the market this year. The highly liquid market prior to Russia’s invasion of Ukraine meant European loans entered the downturn with a firm structural underpinning, and without significant maturity pressure before 2026, which then peaked in 2028. Even so, sponsors — fearful that CLOs could struggle to push out maturities because of reinvestment limitations — took to the extension trail with aplomb. “Sponsors have been proactive and debt investors have been receptive in return,” summed up one manager.

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Across the year, total European loan extension volume has reached nearly €40 billion, which compares with roughly €30 billion in other institutional loan supply. This activity has successfully dealt with the vast majority of borrowers’ 2024 needs, leaving just a stub of either distressed or other deals to be taken out through other means. The lion’s share of 2025 requirements have also been rolled, and the focus has therefore shifted to the later part of that year, or to 2026 maturities.

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What’s more, sponsor pragmatism means these players have been willing to contribute further equity to delever otherwise well-performing assets where needed. Silver Lake Partners-backed ZPG, for example, completed a £952 million-equivalent loan extension in October following a £110 million equity injection that reduced a second-lien loan.

Private credit has helped out too, and Finastra wrapped a $4.8 billion financing in August that took out cross-border term loans due 2024. That deal came after the sponsor made a $1 billion injection of preferred equity, and managers add that if this had been on offer initially, there is good reason to think a deal would have been available in the syndicated market. There is also doubt among managers regarding whether direct lenders will be as amenable to other near-term maturity needs in the syndicated market. “There is no great desire from private credit to take on other people’s problems,” commented one manager.

Helping hand
For ramping CLOs, the spare paper coming loose from those unable or unwilling to roll in extensions has been helpful in filling vehicles, and bankers add that no amend-and-extend has struggled this year due to reinvestment issues. As a result, few borrowers have had to leave the unextended stubs that were typical in the wave of extensions that followed the GFC. That said, there are some notable exceptions, such as Upfield/Flora, which left €527 million and £164 million stubs on the European tranches of its cross-border extension that closed in July. The KKR-backed borrower has subsequently returned with dollar and euro add-ons, but still has the June 2025 stubs as well as a 2026 unsecured tranche to address next year.

The support for extensions comes in a year when technicals rather than fundamentals have driven market sentiment. “If there had been more LBO issuance then I don’t think the market would be trading where it is today,” said one manager, adding that CLO issuance has been leading pricing, rather than supply. “We are slaves to the CLO technical,” adds another manager.

CLO issuance has consistently outweighed new-issue loan supply this year, with the latter measure even running negative during a couple of months when allowing for repayments. Even so, after some movement through the year there is agreement that margins — which are shaking out at roughly E+450 for an archetypal strong B-flat name — are offering fair value. “On an all-in basis, yields of 9% are attractive for secured debt,” said one manager.

Sector dispersion
There is also considerable dispersion within margins in terms of sector and credit story. In the cyclical chemicals industry, for example, BB/Ba3 rated Ineos Quattro paid E+450 and three points of OID for an €875 million term loan due March 2029 that was part of a refinancing and M&A package. That deal came the same time as CVC-backed and B/B3/B rated Cooper Consumer Health more than doubled its debt stack with a €1.105 billion term loan that priced at E+475 and 98.5.

The market is once again tightening, even if margins look stable for now. “OIDs are shrinking and this is the first sign of a tightening market,” said one manager. Among recent deals House of HR, Toi Toi & Dixi, Kereis, Global Blue and Silae all closed with tighter-than-guided OIDs.

This dynamic could open the way for repricings. Last week in the US, CD&R-backed Indicor set a repricing of its cross-border term loan that seeks to trim the margin on a €299 million euro tranche by 50 bps to E+450. “A tsunami of repricings are heading their way to the US,” said one global manager. “The opportunity is not as great in Europe, but it is there.” Traders agree, noting there is a growing cohort of high-margin names trading through par on both sides of the quote.

Stellar returns
Repricings are never popular for managers, but they should not detract from a stellar year for loan investors. A sell-off in sympathy with a volatile rate market in October brought only the second month of negative returns across 2023 for the Morningstar European Leveraged Loan Index (ELLI), and this was partly reversed through November, with year-to-date returns now running at more than 12%. On this reading, European loans are one of the best-performing liquid asset classes globally in 2023, with a good deal of the return coming from higher rates. Recovering prices have further supported returns, taking the ELLI from 91.34 at the start of the year to 95.60 by this week — though the index is still away from its September high of 96.69.

The ability to reprice loans puts a limit on capital appreciation, and managers agree that next year is unlikely to bring a repeat of such impressive returns. That said, loans still offer a strong income story, even if fixed-rate markets start to attract more inflows ahead of expected central bank loosening at some point next year. “You could spend six months or so waiting for rate cuts so there is more certainty in loans,” said one manager.

Whatever 2024 brings, few are expecting any major shift in market dynamics come January. The outlook for M&A deal-making is still far from clear and, while there are some chunky deals lining up such as Zegona Communications, Masmovil and potentially a take-private from Applus, the pipeline is not bulging. This should keep the way open for extensions and other opportunistic add-ons, especially if the CLO machine makes a rapid restart in the new year as expected. “The technical could well move further towards borrowers in January, especially if new issues — as is often the case — are slow to get started,” a manager concludes.

Featured image by Xuanyu Han/Getty Images

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