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LevFin Highlights 1H23: Playing catch up

Rebound in high-yield activity buoys 1H23 LevFin volumes

Leveraged finance (LevFin) issuance across the US and European institutional loan and high-yield (HY) bond markets totalled USD 287bn in the first half of 2023, falling just 8% shy of the volume raised in 1H22. Nevertheless, the figure doubled from just USD 143bn raised during 2H22, bolstered by a strong rebound in HY activity on both sides of the Atlantic. Quarter-on-quarter (QoQ), LevFin issuance rose 11% to USD 151bn in 2Q23.

Markets cracked on as wobbles in the US regional banking system appeared to be contained and losses from the forced rescue of Credit Suisse by UBS were mainly limited to AT1 bonds, while the macroeconomic backdrop turned out to be more constructive despite pressures from persistently high inflation and the consequent central bank rate hiking cycle.

Long-running fears of hawkish rate hikes triggering a recession have yet to materialise, with consumer spending and labour markets showing more resilience than previously projected. Notwithstanding some softening, issuers generally posted better-than-expected first quarter earnings results. But while fundamentals looked healthier than anticipated, default rates inched up and are expected to rise rapidly as rising interest rates erode cashflows and render capital structures of weaker credits unsustainable.

High-yield bond markets rose from the ashes this year, with US issuance clocking in USD 80bn across 90 bond transactions in 1H23. The figure marks a 159% jump on the mere USD 31bn of bonds issued in the second half of 2022 and a 32% increase from USD 60bn raised in 1H22.

Following a temporary retreat amid woes in the regional banking system, the US HY market activity bounced back in April and boomed in May despite a period of ongoing uncertainty surrounding the lifting of the US debt ceiling. Although activity cooled off in June, 2Q23 issuance rose 33% from the previous quarter, churning in USD 46bn across 50 transactions.

In the US leveraged loan market, institutional issuance in 1H23 recovered from the lows of 2H22, but it was nevertheless down 26% when compared to USD 195bn raised in the first part of 2022. In total, USD 144bn was allocated across 214 institutional loans during the first half of

2023, split almost evenly between the two quarters. February was the busiest month in terms of loan issuance, while market activity also picked up paced in May and June.

In Europe, the HY bond market also staged a strong comeback in 1H23 with USD 26bn raised across 56 transactions, almost quadrupling from USD 6.7bn netted in the second half of last year, while representing a 23% YoY increase on USD 21bn in 1H22. April and May were the busiest months in terms of issuance, with 2Q23 volume climbing 36% to USD 15bn from USD 11bn transacted in the first quarter.

The European institutional loan market recorded a 15% YoY increase on the back of USD 38bn raised across 60 transactions in 1H23. With USD 18bn and 19bn allocated across 1Q and 2Q23, institutional loan issuance almost caught up with USD 21bn raised in 1Q22 and rose well above the quarterly volumes of USD 12bn and under in the latter part of 2022.

Shifting gears: new HY issue yields slide below loans

Although loan margins descended from the heady heights of last year and original issue discounts (OIDs) tightened, yields on new issue loans rose above those seen in the HY markets as base rates continued to soar. The three-month SOFR and Euribor rates ascended to 5.26% and 3.58% at the end of June, while the weighted average margin on new US and European loans stood at around 461 basis points (bps). Although running below the levels in December, the average margin in the US rose from 436bps in 1Q23, while it tightened in Europe from 475bps.

In the HY bond market, weighted average yields on new issues in the US and Europe fell to 8.4% in 1H23 from 9.8% at the end of 2022, supported by better technicals.

On the rally: loan prices and bond yields tighten

Secondary loan prices rallied in large part of the year on the back of strong CLO demand. In the US, the weighted average loan bids peaked at 94.87 in mid-June following the Federal Reserve’s decision at the start of the month not to raise interest rates but retreated to 92.74 at the end of the month. At the same time, the average loan bids in Europe climbed to 92.37, softening to 91.56 at the end of June.

Secondary US and European HY bond yields fell from weighted averages of 8.73% and 7.38%, respectively, at the start of January, to hit lows of 7.56% and 6.49% respectively at the start of February. However, average yields subsequently climbed back up in anticipation of further interest rate hikes and the subsequent news of bank rescues ending at 8.42% in the US and 7.24% in Europe at the end of June.

Primary drivers: A&Es and refis proliferate

Refinancing and amend-and-extend (A&E) transactions dominated the LevFin space this year, particularly in Europe where the pipeline for mergers and acquisitions (M&A) and leveraged buyouts (LBOs) remained thin on the ground. Although bankers reported an uptick in M&A discussions this year, deals often failed to materialise. But while a higher deal death rate stemmed in part from a mismatch between seller and buyer valuations, private creditors have also been increasing their share of the M&A market. Underwriting large public-to-private deals that take a long time to come to market has become particularly challenging for banks, following considerable losses incurred last year. With banks asking for large flexes to compensate for market volatility risks, some sponsors have opted for higher, but certain pricing offered by private debt financiers.

M&A-related financing has also been shifting away from loans to HY bonds, more notably in the US, amid more attractive technicals, while hybrid structures involving bonds, loans and private debt were also seen on both sides of the Atlantic.

At the same time, private creditors have also been stepping in to refinance broadly syndicated loans, particularly of the more levered credits for which existing lenders would typically demand an equity injection before proceeding with a refinancing or an extension.

In the US, refinancing, repayments and recaps totalled USD 82bn, accounting for 54% of the HY bond and institutional loan issuance in 1H23. M&A/LBO financing totalled USD 124bn in 1H23, or about 35% of the total, while LevFin issuance for general corporate purposes (GCP) made up the remaining 11% of the volume.

In Europe, M&A/LBO financing amounted to USD 13bn or just 20% of the 1H23 loan and HY bond issuance. Refinancing, recap and repayment transactions netted USD 40bn, representing 62% of the total, while GCP accounted for 18%.

From sprint to crawl: CLO issuance slows down at quarter-end

CLO issuances steamed up in the first quarter as anchor investors resurfaced and liability costs started tightening, reaching USD 33bn in the US and EUR 6.7bn in Europe. After some softening in March and April, CLO printing picked up pace in May. However, as demand for paper outpaced the supply of new loan issues, managers continued to ramp up through the secondary markets, in turn driving loan prices up. In the absence of a similar price tightening in CLO debt tranches, rising loan prices started hurting the already thin arbitrage, leading to a slowdown in new issues in June.

In total, new CLO issues in 1H23 reached USD 52bn in the US and EUR 11.7bn in Europe, down 13% and 15% YoY, respectively. Refinancings and resets have been largely absent since 2022, with no reissues since 2021.

With direct lenders taking an increasing share of debt markets, issuance of CLOs backed by private credit also increased in the US, while there are expectations that mid-market deals could soon surface in Europe.

Popular sectors: US technology and European chemicals top the charts

The computers & electronics sector continued to top the LevFin charts in the US, hauling in USD 30bn this quarter, while oil & gas and chemicals followed with USD 21bn and USD 20bn, respectively. Insurance trailed with USD 19bn, and USD 16bn was raised in the leisure & recreation sector.

In Europe, the chemicals sector led with USD 10bn, while professional services followed with USD 9bn. Leisure & recreation generated USD 6bn, while the computers & electronics and retail sectors each punched in USD 5bn.