Lending lowdown Podcast

State of the European Lending Space

Episode 5, Season 1

A look at the European leveraged and investment grade loan markets. Is leveraged lending shut down in Europe? What opportunities have arisen for the private debt space as a consequence of this disruption? And is there a silver lining in the investment grade market?

Host: CJ Doherty

  • Ioana Barza: Welcome to the Lending Lowdown. I’m Ioana Barza, head of market analysis. I’m joined by CJ Doherty, director of analysis. We are excited to host our fifth episode together. We really wanted to step up our game, so we brought you three guests today.

    CJ Doherty: Yeah, it's a bit ambitious, but when it comes to the European loan market, we couldn't think of a better crew than our editorial folks in London. So Eleanor Duncan, Prudence Ho and Alasdair Reilly, welcome to the Lending Lowdown:

    IB: And it is ambitious. So thank you for joining us and talking with us a bit about what's happening in the European loan market. But before we start, could each of you tell our audience your focus. Alasdair, why don’t we start with you?

    Alasdair Reilly: Hello, I’m Alasdair Reilly. I'm a senior reporter covering the European investment grade loan market.

    Eleanor Duncan: Hey, I'm Eleanor, I'm EMEA leveraged loans editor. I've been covering capital markets for 10 years, starting in New York and now in London.

    Prudence Ho: Hi everyone. This is Prudence. I cover European private debt.

    CJ: Eleanor, let's start with you. The European leveraged loan market, like it's US counterpart, has faced difficult conditions in recent months to say the least. So is the leveraged loan market currently shut down in Europe. What's going on there?

    ED: Europe's leveraged finance market is really at an almost standstill. On the buyside, there's not a lot of liquidity out there. Investors are feeling very risk averse in light of rate rises, inflation and Russia's war in Ukraine. They've also seen outflows more recently on the back of the UK's recent LDI turmoil, which has caused big losses for pension funds, we have seen that flow through into leveraged loan investors and also high yield bond investors. So we're seeing that banks effectively shut for business in terms of underwriting new buyouts. Banks are telling us that they are either unwilling to take on new risk or are asking for terms that are either too flexible or too expensive for sponsors. And that's partly because leveraged finance participants have already suffered quite painful losses this year on billions of buyout financings that were underwritten in better times, but were then sold to investors at steep discounts as the market stalled. That hung pipeline has now been whittled down quite a lot. And banks say that they don't want to add to their problem and put more deals onto their balance sheets. One banker recently said that to underwrite something new now and not then be able to sell it in two months would feel like, as he said, a self-inflicted wound. To be honest, there hasn't been much M&A activity going on anyway. And for deals that have been already underwritten, banks have had to rejig financing in order to get them through a very nervous primary market, often bringing in direct lenders or even other banks to get deals across the line. And even then yields have been seen at around 10% or more.

    CJ: And thinking about risks and the leverage market. Are maturing loans a concern for both lenders and sponsors or not so much?

    ED: You know, something the banks have been worrying about in recent weeks rather than the hung M&A pipeline, which was a focus, I think from April onwards and over the summer. Now they're looking at the potential impact of the lack of liquidity for borrowers with near term maturities. Europe's leveraged companies have around 9 billion dollar equivalent of Term Loan Bs maturing in 2023-2024. There's also over 60 billion of euro denominated high yield debt maturing in 2023. So in normal years that wouldn't be considered a huge number. But the future is very uncertain. Borrowers are facing a market where their cost of capital may double or even triple. We saw Swedish alarm company Verisure, which is considered a very strong non-investment grade credit. And they recently priced at 500 million euro senior secured refinancing bond at a coupon of 9.25 per cent. Now the bonds that the company were replacing had a 3.5% coupon. And that really shows you how much the market has soured over this year. Bankers are saying that credits that have a more checkered history might get a rough ride in primary or will require capital injections in order to delever. And we might see a number of distressed amend and extends going through. So yeah, very uncertain times lying ahead.

    CJ: That's great. That's a lot to keep an eye on going forward. Let's shift over to the private debt side and Prudence. What opportunities have arisen for direct lenders as a consequence of the disruption in the leverage market?

    PH: It has been a great year for European private debt markets, as they are the only source of liquidity in the market after banks have shut for business in terms of underwriting any new financing. So the key advantage that private credit funds could offer right now is certainty. So they can price risks and provide certainty in terms of cost of capital, execution and documentation which banks couldn't offer. Now, they have to seize this opportunity to step into the larger end of the leveraged market to fund everything, from new buyouts to refinancing and add-on. They have also taken down loans that banks couldn't shift in the leveraged market, or so-called hung deals. We have seen earlier this year the underwritten banks of Morrisons sold part of the financing to a group of lenders at a very deep discount. By taking all these opportunities, they got a very attractive return. The all-in yield in some cases is 10% or above. They can even negotiate really better terms in documentation to tighten up covenants, cash leakage and assets leakage. It’s not doubt that is the time for them to shine. And They might even take a permanent market share in European leveraged market, even if the market dislocations ease.

    CJ: So it sounds like there's loads of opportunity. Are there any challenges that this market is facing, or is it pretty much positive for them at the moment, given the problems that the leveraged market faces?

    PH: For them is like they have keep all the cards for now, so they see loads of opportunities for them. And also they don't see a lot of defaults going forward because what they finance is basically recession proof sectors. Healthcare, software, business. So for now, they seem pretty okay, but we'll see how this stress will come into markets in the next 12 to 18 months.

    IB: There's so much focus here on risk management and we obviously see it in the US market as well, and just a lot of differentiation by risk. So now I want to switch Alasdair over to you to the less risky part of the market. What about investment-grade? Is it insulated from all this? Is it taking any kind of hits. The dynamics are so different in investment grade.

    AR: As they say the investment-grade market is never closed, but sometimes it’s only open at a price. So we’ve seen volumes drop substantially on the back of rising interest rates, inflation, supply chain issues, the energy crisis and the war in Ukraine, which has created long-term uncertainty and prevented a full recovery from the pandemic. Refinancing, the traditional driver, of investment grade loan volumes, is around 50% down on last year.

    IB: Wow.

    AR: Margins for investment grade European corporate are rising modestly as banks’ cost of funding also rises, stymieing any opportunistic refinancing activity. Borrowers are really sticking with what they've got. Borrowers have made wide use of extension options on their existing facilities to avoid having to pay up to fully refinance their loans. But modestly increasing margins might not be the main barrier to appetite. Rising underlying interest rates could prove a real dampener on activity going forward as the era of cheap financing comes to an end. Now that's not a problem for the vast majority of investment-grade loan issuance, which are in the form of undrawn revolving credit facilities, which only pay a small commitment fee, not connected to a base rate. But it does affect appetite for drawn revolvers and term debt, making them materially more expensive, which could see an increase use of interest rates swaps on deals and switch into fixed rates. Meanwhile, M&A financing is around 60% down as uncertain volatile markets hit valuations and appetites to do deals, or difficult and equity markets mean there's no easy takeout option for bridge loans. Bank liquidity isn't a problem. Event-driven financings are far more lucrative for banks that standard vanilla refinancing, and lenders remain more than willing to provide financing to back acquisitions. Borrowers just aren't biting.

    IB: So it might just be what we're seeing in the US market as well. Which is that in some markets the financing is hard to get and it sounds like with the high-grade market, bankers would still be willing to do the M&A. But if you need to refinance, get an extension or just wait it out until you get closer to the maturity. Is that fair?

    AR: Yes, I think so. Many borrowers are taking the opportunity and do the extensions to add ESG criteria to their financing, making them more attractive to add sustainability linked loans to their portfolios.

    IB: Interesting, Interesting. Thank you so much. This was a fantastic overview and finger on the pulse of what's happening right now in the European loan market.

    CJ: Yeah, so Alasdair, Eleanor and Prudence, thank you so much for coming on the podcast.

    IB: We want to thank all of you for tuning in. I’m Ioana Barza here with CJ Doherty, and for all of our EMEA market coverage, please visit us at loanconnector.com and join us in person on November 2 in New York City for our 28th Annual Loans Conference. We will have eight panels tackling these challenges in private credit and in the broader syndicated market. And again, we want to thank all of you for listening to our fifth episode. Subscribe to the Lending Lowdown on your favorite podcast platform.

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