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.
Explore the data
World in Transition
Our views on changing dynamics in energy, ESG, finance, globalization and US policy.
HEADLINES
European leveraged finance markets roared back to life in 2021, sparked by a combination of attractive pricing in the first half of the year and buoyant M&A activity in the second half. The result? High volumes of refinancing and deal-linked leveraged loan and high yield bond issuance in Europe. And the momentum behind these double-digit gains looks set to continue in 2022.
Leveraged loan issuance in the region climbed 28% in 2021, rising to €289.7 billion from €227 billion in 2020, putting the market on pace to reach the highest annual total value for leveraged loan issuance on Debtwire Par record.
European high yield bond markets were even more lively, with issuance for the year coming in at €148 billion—a 47% uplift on the €101 billion posted in 2020 and surpassing annual highs going back to 2015 by the end of the third quarter.
Is this explosive growth likely to continue in leveraged finance markets in 2022?
28%
The rise in leveraged loan issuance in 2021, year-on-year
Leveraged finance issuance continued to rise through 2021 despite the emergence of several challenging factors, including new COVID-19 variants, upward inflationary trends (and the spectre of rising interest rates), supply chain disruption and shortages, elections in France and Germany, and ongoing post-Brexit trade and security tensions between the UK and the EU.
While the rise in overall debt issuance points to a stable, more predictable market, both lender and borrower motivations have pivoted in the past 12 months. Entering 2022, the ongoing evolution of such motivations is somewhat difficult to pin down, though the change in direction is clear. The drivers of issuance have effectively transitioned from survival mode (refinancing) to thriving mode (M&A and buyout issuance).
After almost two years of doing business on pandemic-induced shifting sands, many companies have finally found their footing and are focusing on growth.
In the leveraged loan space, refinancing activity dominated issuance in the first two quarters of 2021, as borrowers moved to cut the cost of the more expensive debt, including that taken on during the first round of COVID-19 lockdowns.
A downward shift in average pricing for pro rata and institutional loan debt—from more than 4% in Q4 2020 to below 4% by the end of Q2 2021—saw a wave of opportunistic activity, as issuers raced to lock in attractive rates.
The high yield market followed a broadly similar pattern, as pricing in Q1 and Q2 came in below the 4% threshold.
The scale of refinancing issuance in the first half of the year was such that it accounted for approximately half of overall leveraged loan and high yield bond issuance in 2021. This despite a significant slowdown in refinancing in the latter half of the year, which was characterised by rising prices. For leveraged loans, the average margin on institutional first-lien debt moved from 3.71% in Q1 to 3.89% in Q4, while the weighted average yield to maturity on fixed-rate bonds increased from 3.87% in Q1 to 4.69% in Q4.
This drop in refinancing weighed more heavily on the leveraged loan market. After a summer pause, institutional issuance failed to match the pace set earlier in the year, with August, September and October ranking among the slower months for issuance in 2021.
While higher pricing deterred opportunistic refinancing, buyouts and M&A issuance in Europe built up momentum throughout the year, even as the weighted average margin for M&A and buyout facilities came in above the pricing thresholds seen at the height of the pandemic.
In 2021, M&A value in Western Europe climbed to its highest level since the global financial crisis, as dealmakers caught up on delayed deal timetables.
High yield bond issuance, in particular, saw a cluster of activity in the final months of the year. LBO financings for Business Integration Partners, Keepmoat, Arrow Global, Agrifarma and Polynt-Reichhold, along with non-buyout M&A deals, such as MÁSMÓVIL, Multiversity and Cerba HealthCare, saw October deal-related high yield bond issuance spike to over €10 billion. The fourth quarter of 2021 accounted for more than a third of overall high yield M&A and buyout bond issuance during the year (€33.2 billion).
This flurry of activity late in 2021 saw year-on-year high yield bond issuance in Western and Southern Europe climb by 53% to €17.8 billion for non-buyout M&A, while buyout-linked issuance more than doubled to €15.4 billion.
For leveraged loans, year-on-year figures saw an 19% jump in non-buyout M&A loan issuance to €54.9 billion, with buyout issuance up 81% at €66.7 billion.
With sponsors and corporates sitting on record sums of dry powder in the form of cash reserves plus ongoing M&A activity, Q1 2022 is shaping up as providing for a steady flow of financing.
In particular, M&A and buyout activity is expected to continue driving issuance in 2022, with a strong pipeline of deals in place. Large deal financings lined up for 2022 include an anticipated €5 billion loan package to fund the merger between auto component manufacturers Faurecia and Hella.
In addition to the full M&A pipeline, other noteworthy factors are set to influence leveraged finance deals in the coming months. For example, borrowers now have more options when it comes to financing. Record levels of CLO activity in November pushed new CLO issuance 75% higher year-on-year, pointing to another powerful year for debt market activity.
It was a similar picture in the European direct lending space. The past 12 months of robust deal flow, fundraising and issuance have confirmed the maturity, resilience and credibility of the industry, which is now set for growth through 2022.
The fundraising numbers alone reflect the industry's increasingly confident position as a stable asset class delivering solid returns. According to data from Debtwire Par, European-targeted direct lending fundraising activity in the first half of 2021 had already exceeded the full year total for 2020. By the end of the year, it had reached €36.2 billion.
At the same time, however, inflation and the threat of rising interest rates, as well as higher pricing and an uptick in the number of flexed deals in syndication processes, suggest that borrowers and lenders alike may have to navigate some choppier waters in the year ahead.
And then there is debt linked to environmental, social and corporate governance (ESG) criteria, which is yet another lever that investors and borrowers will have to factor into their plans. According to White & Case's ESG Leveraged Loan Deal Tracker, ESG-linked loans accounted for close to a fifth of all European term loan B issuance by the end of Q3 2021, a near fivefold increase on the share of only 4% recorded in 2020.
ESG could serve as another spur for debt issuance in 2022, but it will not be a free-for-all as the rollout of new benchmarks—including the EU's Sustainable Finance Disclosure Regulation and the European Leveraged Finance Association's updated Sustainability Linked Loan Principles—introduces greater rigour to ESG financing criteria. Greenwashing and independent verification of ESG performance metrics—both their framing and their testing—are likely to be hot topics for ESG bank loan and bond issuances in 2022.
Lenders and borrowers are preparing for another busy, buoyant 12 months of activity, but will have to navigate additional layers of complexity and nuance to stay on top of these fluid market waves.
White & Case means the international legal practice comprising White & Case LLP, a New York State registered limited liability partnership, White & Case LLP, a limited liability partnership incorporated under English law and all other affiliated partnerships, companies and entities.
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.
© 2022 White & Case LLP
View full image: European leveraged debt in focus (PDF)
View full image: European leveraged loan vs. high yield bond issuance (quarterly) (PDF)
View full image: European leveraged loan pricing (PDF)
View full image: European high yield bond pricing—Fixed-rate bonds (PDF)
View full image: Original issue discounts (OIDs) in Europe (PDF)
View full image: Benchmark floors on institutional term loans (PDF)
