Europe's Leveraged Loans Put on Biggest Show in a DecadeBy
European market achieves highest post-crisis issuance in 2017
Banks seek more M&A in 2018 after deluge of low-fee repricings
Leveraged loan issuance in Europe grew to 80 billion euros ($97 billion) in 2017 - a 52 percent increase on the previous year and a post-crisis record. Yet arranging banks were left feeling frustrated: the mix of business overall wasn’t what they wanted and the pace of borrowing didn’t match investors’ appetite for lending. Now arrangers are looking to 2018 in the expectation of brighter prospects.
See more in Bloomberg’s European Leveraged Finance Chartbook 4Q17
It might seem ungrateful to complain, given that the year brought an impressive increase in new issuance. But borrowers also seized the opportunity to reprice their existing loans, thanks to low interest rates driving cash into the market. Nearly 74 billion euros of paper repriced during 2017 alone.
The ability to reprice is excellent news for companies and sponsors trying to lower their interest bills, and 22 borrowers even managed to reprice twice in one year, but these transactions earn little fee income for banks and are bad news for investors - hence the wish for a change in the year ahead.
“As some of the repricing trends slow, overall volumes could be lower, but hopefully the slack is taken up with a better mix of M&A financings allowing the banks to put more underwritten capital to work,” said Dominic Ashcroft, co-head leveraged finance capital markets EMEA at Goldman Sachs.
There are reasons to be hopeful that more M&A will come to market in 2018, arrangers find, both for buyouts and possibly for more leveraged corporate acquisitions.
“I tend to be optimistic. Businesses have driven costs out to get growth and have done a great job, but they’re running out of cost savings and they need top line growth, some of which will have to come from acquisitions,” said Kevin Foley, head of high-yield and leveraged loans EMEA at JPMorgan.
The second half of 2017 showcased the European loan market’s ability to absorb very large acquisition financings including Nets A/S and Stada Arzneimittel AG. In all, M&A volume grew to 40.8 billion euros in 2017.
Not only are private equity sponsors looking for ways to invest their dry powder, they can also in some cases access additional equity financing from other sources such as deep pocketed Canadian pension funds in order to stretch for larger buyout targets.
“We think that M&A will be a more important feature compared with 2017. Financial sponsors have significant dry powder that they are looking to put to work, and we think the macro picture and growth forecasts in Europe mean there is an increasing focus on the European landscape,” said Mark Walsh, co-head EMEA leveraged finance capital markets at Credit Suisse.
The European Central Bank’s guidelines on leveraged lending, which came into force in November, could dissuade some banks from pursuing aggressive financing structures at every opportunity, but it may be well into 2018 until the impact of the guidelines becomes apparent.
In the meantime, the early pipeline for loan issuance includes buyout financings for Kiloutou SA and Alloheim Senioren-Residenzen GmbH, and corporate acquisition financings for Altran Technologies SA and Cineworld Group Plc. Towering over all this is KKR’s 6.83 billion euros buyout of Unilever NV’s spreads division.
Repricings flourished in 2017 because supply of new issuance fell short of demand, and because there was little volatility in the loan market during the year.
Low interest rates prevailing in Europe continued to push money into the sub-investment grade credit markets in the quest for yield, creating a deep and persistent bid from flourishing CLOs and a raft of other institutional buyers. Borrowers naturally took full advantage, and new issue spreads fell.
In late 2016 the European market was collectively pondering whether lenders would tolerate spreads of Euribor plus 400 basis points. In the following 12 months, buyers showed appetite well below that mark, and even below Euribor plus 300 basis points for double B paper, and now are again asking if the market is reaching the bottom.
The prospect of new-issue loan pricing dropping again in 2018 falls into what Credit Suisse’s Walsh calls the “never say never” category. Walsh added, “We continue to be surprised to the upside on the demand from CLOs, managed accounts, and other institutional investors for loan product.”
If supply again fails to meet demand, and if there are quiet periods in the flow of new issuance, the European market could see further contraction on new issue spreads as well as more repricings. CLOs’ cost of funding will in part dictate how steep this contraction could be, but there are many other buyers of loans and some of these are relatively insensitive to tightening of pricing.
Dividends and Refinancing
Away from repricings, fresh loan issuance in 2017 was also driven by this cheap and flexible form of funding being used to replace equity in buyouts, and to replace high-yield bonds.
Sponsors tapped the market for numerous dividend recapitalizations, using senior secured loans to repay some of the equity used to buy a business: Verisure Holding AB, ION Trading, and Exact Holding were among those to do so in the fourth quarter.
If leveraged companies grow during 2018 in a healthy economic environment in Europe, sponsors should be expected to return to take more equity out via the loan market, and loose documentation means that borrowers are not obliged to delever.
Companies also continued to repay high yield bonds with loans - a trade that became popular in 2016 as covenant lite loans became the norm. Last year, about 80 percent of institutional loan issuance was covenant lite.
“We’ve not had the huge M&A volume we hoped for, but loans have still benefited from the bond-to-loan trend, and that trend will continue for the foreseeable future,” said JPMorgan’s Foley.
(Ruth McGavin is a leveraged finance strategist who writes for Bloomberg. The observations she makes are her own and are not intended as investment advice.)
— With assistance by Azat Davletkhanov