Leveraged finance issuers have continued to benefit from borrower-friendly terms and conditions in 2021, despite wider macro-economic headwinds.
Sustained demand for yield from cash rich lenders—despite rising inflation and supply chain dislocation—has supported a recovery in high yield bond and leveraged loan issuance in the US and Europe following COVID-19 volatility.
US leveraged loan issuance has already exceeded US$1 trillion in the first nine months of 2021 and is ahead of the 2020 US$861.7 billion full year total. Issuance of US$254.1 billion in Western and Southern Europe for the year to the end of Q3 is already close to annual takings of US$259.59 billion for the 2020 calendar year.
Similarly, in high yield markets, European issuance of US$139.2 billion over the first three quarters of 2021 has already exceeded the US$113 billion 2020 annual tally. In the US, issuance of US$365.2 billion for the year through Q3 2021 is up 7% year-on-year.
Competition influences US pricing
This steady rise in issuance, coupled with strong investor appetite, has generated increased competition for credits. Borrowers have secured attractive pricing on debt even though there is growing acceptance that debt costs are likely to rise in line with anticipated increases in interest rates in 2022.
In the US, the average margin on first lien institutional loans over the past 12 months tightened from 4.17% in Q4 2020 to 3.63% in Q3 2021, according to Debtwire Par. Pricing edged slightly higher between Q1 2021 and Q2 2021 (from 3.47% to 3.74%) before trending back down in Q3.
According to Debtwire Par, a surge in US buyout financings and correlated investor demand contributed to the lower average pricing seen in Q3 2021, with average margins on buyout loans dropping from 4.24% in Q2 to 3.99% in Q3.
Original issue discounts (OIDs) and LIBOR interest rate floors also moved in favor of borrowers during Q3 2021. Average OIDs dropped to just 0.59% in September, while average LIBOR floors dropped from 0.89% in August to 0.5% in September. More than a third of LIBOR floor thresholds in the US (36%) for the year to the end of Q3 2021 were set at 0.5%. By the third quarter of the year, 59% of deals had floors of 0.5%.
The cost of US high yield bond capital also trended lower, with overall US high yield pricing reducing in each quarter this year from an average of 5.18% in Q1 2021 to 4.63% in Q3 2021. Well over half of US bonds issued in the first three quarters of this year (57%) have a yield of 5% or less, versus 43% over the same period in 2020.
European pricing edges higher
In Western and Southern Europe, meanwhile, loan pricing followed a slightly different tack, and did not tighten to the same degree as in the US market. European loan pricing moved lower in the past year, with the average margin on first lien institutional loans down from 4.01% in Q4 2020 to 3.86% in Q3 2021. Since Q1 2021, however, when the average margin in the region was 3.71%, pricing has trended upward. Pricing increased as refinancing activity cooled after a busy start to the year, according to Debtwire Par.
The cost of high yield financing in Western and Southern Europe also edged upward throughout the year, with Debtwire Par recording an increase in the weighted average yield to maturity on fixed rate bonds to 4.30% in Q3 2021 from 3.87% in Q1 2021.
Interest rate floors in Europe, however, tracked US patterns. Almost all European institutional loans in the first nine months of 2021 had 0% floors, with issuance figures showing the highest proportion of 0% floors since 2015. The picture for OIDs in the region is more mixed. The share of OIDs offered at between 99.5% and 100% of par is significantly higher than in 2019 and 2020, although deeper discounts of 99.5% and less were more frequent than in previous years.
Although European pricing moved higher in 2021, the cost of capital remains low by historical standards and much improved from 2020 levels. Market conditions remain highly attractive for borrowers.
Lenders are more selective
As eager as lenders have been to deploy capital, however, borrowers have had to make some concessions on pricing and terms, even as market dynamics broadly favored them.
Terms limiting the scope for borrowers to move intellectual property and other assets into unrestricted subsidiaries, and thus out of the reach of existing lenders, have become more common in documents. So too have lender protections against the practice of layering additional debt into capital structures—thus subordinating existing borrowing—without securing incumbent lender consent.
Lenders have also been more selective about the transactions they back, given the high volume of borrowers coming to market, hoping to lock in deals ahead of a potential downshift in the credit cycle.
High-quality credits backed by recognized sponsors continue to attract significant lender interest and are thus able to drive a harder bargain on pricing and terms.
Credits that have any wrinkles, however, are finding it more challenging to clear the market without making compromises.
SVP Worldwide, the owner of the Singer and Viking sewing machine brands, for example, had to reduce the price of a US$370 million loan to fund a Platinum Equity deal from a discount of 98% of face value to 93%. Even though the company traded strongly under lockdown restrictions, as housebound consumers picked up sewing as hobby, lenders pushed back on terms of the deal on the grounds that revenue growth could slow once economies reopened.
Roofing contractor Flynn Group, meanwhile, reduced the size of a loan earmarked for share buybacks, dividends and debt repayments from US$300 million to US$250 million. The OID on the loan moved from 99.5% to 97%.
Examples like these remain the exception to the rule but do demonstrate that lenders are keeping an eye on credit quality and risk amid the race for yield.