Misplaced optimism in the levfin market
Positive expectations for the new year are veiled behind the specter of 2022
The leveraged finance market has started the new year with a generally constructive and positive tone. But, the market should remain cautious of this new found optimism.
Bankers believe that the drop of energy and gas prices by around 80%, when compared to the peak between September and October, has installed positive sentiments about how the coming year is going to play out at the macro level.
Market concensus is that 2023 has started stronger than expected. But, considering that European leveraged loan issuance declined by 43.9% to €77.07bn last year, from a record high of €137.46bn in December 2021 according to Fitch, it wouldn't take much activity to cause excitiment.
Although activity has increased, there is not a lot of new issuance, with the market dominated by refinancings. Of the four deals currently being marketed in Europe, three are to refinance existing debt and the other is an add on for an acquisition. This means that investors have only limited options for places to invest cash.
The perception is that the forward-looking LBO pipeline is less forward than what there has been for years, even though the acquisition side of the market has expanded when compared to 2022. Issuance this year will likely continue to be driven by refinancings and small add-ons, rather than straight M&A, which will be short rationed especially in the first half.
Yet, bankers are keenly advising clients that this is a promising mirror and to take advantage of the bouyant market window, which is reflected in how the deals are going. However, with only a limited number of transactions on the market, the trend is not yet established. Demand from investors is high, as demonstrated by loans issued by Restaurant Brands Iberia — which was increased to €310m from €260m — and Port Aventura — which was increased to €640m from €620m. However, there is a lack of supply on the issuer side stuck between the market closure in 2022 and the upcoming recession expected by the end of this year or the start of 2024.
Lenders and arrangers perceive the intermittent pipeline as a positive sign, having become accustomed to a dead market for most of last year. But with a recession likely on the horizon, none can rely on the expectations that acquisition activity will increase by the end of the year.
Some are still shy to invest in junior credits due to the fears of rising default rates, where in some instances the evidence suggests they already have. Investors are looking for positive returns, so are interested in high quality deals and being selective for credit. Eventually, with evaluation coming down, there will be a need to overcome these fears if they are to engage in strategic buying.
The transactions that have entered the market in 2023 have so far been successful, and have come from some strong names in the levfin market such as UK chemical group Ineos and telecom company Altice. In a stark parallel to last year when certain deals had to be pulled due to market volatility, TenCate Grass has come back to the market after its €274.3m loan was postponed in September.
Nevertheless, the nearly non-existent M&A pipeline does not support the positivism currently on display from investors and arrangers, given it is the main source of new money in the leveraged loan market, and they would be wise to tread carefully.