Imagine the scene. A market is quiet for the first few months of a year, as a cloud of volatility hangs over the City. The LBO deals that do happen go pretty well, and pricing edges downwards (of course — supply-demand is in the sell-side’s favour). An air of confidence grows among underwriters, who begin to pitch aggressively for mandates, and a healthy pipeline begins to appear.
But all of a sudden, the world remembers the eurozone is hanging by a thread, and markets are plunged into chaos.
What happens next?
In leveraged finance, 2011 edition, some investors turn their noses up at the leverage levels on some of the credits in the market, while others realise they have the upper hand during syndication as secondary loan prices fall. Banks are left long on underwrites, and the rest of the year becomes a painful game of cat and mouse as the hung deals are slowly sold at hefty discounts while the primary market is non-existent.
Leveraged finance, 2012 edition, finds itself in an eerily similar position to this time last year. But that is no reason to expect a similar outcome. To avoid last year’s disappointments, banks must, above all, make sure that credit risk, as well as syndication risk, is top of their priorities. Being able to sell a deal simply because there is liquidity in the market is not a demonstration of good banking. Being able to lever up a company and price risk appropriately is. The aggressive structures were those that got stuck in the market last year.
Sponsors must accept that pushing for very high leverage multiples is unrealistic in today’s market, and should also allow banks leeway on flex terms. If this means lower returns, tough — everybody’s expectations are down in dark days like these.
And investors must be more open and consistent with underwriters about how much cash they have to deploy and how much they need to be paid for certain risks. The US investor base operates in this more efficient manner and thus allows the market to pick itself up and carry on much more swiftly after crises.
Investors cannot complain about the pipeline if banks feel deceived by certain accounts and are left scared of bringing deals to market.
On the bright side, the volumes being underwritten this year are nowhere near the €10bn or so that was left un-syndicated in 2011. However, liquidity is not as great either, as the loan market has not benefited from the same levels of repayments as those that came from 2011’s rampant high yield issuance.
Moreover, in 2012 it is more crucial than ever than levfin proves it is capable of stability. Fundraising is even higher on the agenda thanks to CLO reinvestment periods expiring, but no matter how attractive the yields may be for a senior-secured instrument, if there are no loans to buy, nobody will allocate money to buying them.
