European leveraged finance markets look remarkably healthy as we enter 2022. This may come as a surprise, after 12 months of economic volatility underpinned by everything from a new COVID-19 variant to growing inflationary pressures. What does this mean for the months ahead?
The start of the new year is full of positives in the European leveraged finance market. There has been a clear shift from survival to growth strategies among lenders and borrowers, setting the stage for significant activity in almost all sectors.
The numbers paint a clear picture. European leveraged loan issuance climbed more than 25% in 2021, year-on-year. High yield bond markets in the region were even more enthusiastic, with issuance for the year up 47% on 2020's total.
Ongoing government support in the EU and the UK helped companies that might otherwise have fallen victim to the pandemic stay afloat. Low interest rates and pricing sparked a wave of refinancing. CLO activity—most of which was intended for refinancing and resets—pushed new CLO issuance up by 75% year-on-year.
A bottleneck of demand as well as significant private equity dry powder also brought a flood of new deal money into the market. Companies that were once hesitant to sell encountered enthusiastic buyers aggressively looking for targets. Buyers, meanwhile, found themselves in a better position to judge whether a potential target was likely to struggle or grow in 2022 and beyond. Lenders reaped the benefits, with high deal volume in which to participate. At the same time, unlike many other industries, European direct lending funds avoided any significant downturn in deployment and deal activity due to COVID-19. According to data from Debtwire Par, direct lending issuance in the region reached €36.2 billion in 2021, surpassing 2020's full-year total of €21.4 billion. This provided a liquid and competitive market for finance products.
Possibilities and pitfalls
Set against this positive backdrop, does the future look entirely bright for leveraged finance? Not necessarily—some challenges remain, and each may have an impact on European issuance.
For example, climbing COVID-19 case numbers driven by the Omicron variant may convince some corporates to hold on to their reserves. Any resulting new lockdowns or restrictions could also be the final straw for businesses that have already struggled during the pandemic.
Inflation and attendant interest rate rises are also likely to influence potential borrowing decisions in the coming months. The UK got the ball rolling with its first interest rate rise in three years in December 2021, and the EU may follow suit in 2022—despite claims to the contrary by the European Central Bank.
Any rise in the cost of debt will affect M&A and buyout activity, as well as financing. Some may pause while others—from corporates in good financial shape to PE firms with money to spend—may decide to invest in a post-COVID-19 future. Either way, M&A and buyout deals in the pipeline already suggest that issuance will remain healthy in the first half of the year at least.
And, finally, environmental, social and corporate governance criteria will be on the menu for every European business. New benchmarks due in 2022—from the EU's Sustainable Finance Disclosure Regulation to the European Leveraged Finance Association's updated Sustainability Linked Loan Principles—are already making lenders and borrowers sit up and take notice.
All this activity means the stage is set for companies hoping to thrive rather than simply survive. Lenders chasing higher-yield opportunities will be on the hunt for new investments, and borrowers can be expected to provide lenders with a healthy volume of demand for debt financing in 2022.
Selected European leveraged loan and high yield bond markets by volume and value
A flurry of activity saw year-on-year leveraged finance issuance in Europe hit new heights in 2021. Can this pace be maintained in the months ahead? Based on pipeline activity and investor appetite for growth, the answer seems to be: Yes.
A flurry of activity saw year-on-year leveraged finance issuance in Europe hit new heights in 2021. Can this pace be maintained in the months ahead? Based on pipeline activity and investor appetite for growth, the answer seems to be: Yes.
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As we enter 2022, there are plenty of reasons to be cautious about leveraged finance in Europe. The economic impact of the latest COVID-19 variant remains an unknown quantity, inflation continues to climb and rising interest rates look increasingly likely—the UK was the first major economy in the region to raise rates and the EU may follow suit.
€289 billion
The value of leveraged loan issuance in Western and Southern Europe in 2021
And yet leveraged finance activity continues to defy expectations. Last year saw the highest annual total value for leveraged loan and high yield bond issuance in Western and Southern Europe on Debtwire Par record. Meanwhile, direct lenders raised record levels in their funds and deployed them in a record-setting year in 2021, including in the private equity (PE) space where direct lending is finding increasing inroads.
€148 billion
The value of high yield issuance in the region in 2021
As outlined in this report, the drivers for this activity were clear. Refinancing issuance in the first half of the year accounted for approximately half of all leveraged loan and high yield bond issuance. M&A deal value in Western Europe climbed to its highest level since the global financial crisis, establishing a steady stream of financing that has not yet reached its conclusion.
Where does this leave European leveraged finance for the year ahead?
There are several pockets of activity worth watching over the coming period.
First, M&A activity—coupled with private equity's ongoing buyout spending spree—has a way to go.
Year-on-year high yield bond issuance supporting M&A (excluding buyouts) climbed by more than 50% in 2021, while buyout-linked issuance more than doubled. There was also an 19% year-on-year jump in non-buyout M&A leveraged loan issuance, with buyout issuance up 81%.
Much of this was down to a spike in megadeals in Europe in 2021, with more than 150 deals worth at least US$2 billion and seven worth at least US$20 billion recorded last year, according to Mergermarket, including the US$31 billion tie-up of Vonovia and Deutsche Wohnen. And where M&A goes, issuance follows.
Second, on the PE side, sponsors spent more than US$300 billion in 2021, almost double the year before and the highest annual value on Mergermarket record—a trend that is likely to continue in 2022. Many PE firms have already raised material new funds or are in the process of doing do, and those will need to be deployed. All of this feeds into debt and equity markets and will keep things moving in the year ahead.
And third, while the latest variant in the pandemic will likely continue to influence decisions for lenders and borrowers alike, environmental, social and corporate governance (ESG) issues will remain on everyone's radar. The onset of ESG financing has created new opportunities for the market and this can be anticipated to grow in 2022.
For many, it's a question of regulations. The EU's Sustainable Finance Disclosure Regulation, which came into effect in March 2021, 'lays down sustainability disclosure obligations for manufacturers of financial products and financial advisers toward end-investors'. More detailed information will be required from lenders in Europe hoping to hook their wagon to the ESG train—any hint of 'greenwashing' will not be tolerated.
At the same time, where available, margin ratchets linked to ESG or sustainability criteria will offer borrowers a potential means to reduce the cost of debt, especially notable if interest rates rise. This also allows lenders to cast their net wider in pursuit of yield, giving them a means to lower risk on credits that they might otherwise not pursue. It's a win-win scenario for both parties that could create a more sustainable finance and investment market.
Lenders and borrowers should prepare for another busy year, but keep in mind that these big waves of activity will not last forever. Ride them for as long as you can, but be ready to batten down the hatches for the next storm.
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This article is prepared for the general information of interested persons. It is not, and does not attempt to be, comprehensive in nature. Due to the general nature of its content, it should not be regarded as legal advice.
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