At the beginning of 2024, the White & Case leveraged finance team made a series of predictions on how the leveraged loan and high yield bond markets would perform in 2024.
After 12 months of softer markets in 2023, the team anticipated that key psychological triggers would define how lenders, investors and borrowers would return to market in 2024.
Below are the five predictions made at the beginning of 2024, along with an evaluation of how accurate each has proven to be:
Prediction 1: Restlessness
The team forecast that after a slow 2023, restlessness among sponsors and credit providers would propel all parties to transact. With maturities approaching and capital to put to work, the market sprang back to life in 2024.
Leveraged loan and high yield bond markets have rallied in 2024. By the end of Q3, both European leveraged loans and high yield bonds had almost doubled the levels of issuance during the same period in 2023. Leveraged loan issuance totaled US$244.6 billion, up from US$123.8 billion the year before and the total value of high yield issuance exceeded US$110.1 billion compared to the US$65.3 billion between Q1-Q2 2023.
Drops in interest rates in Europe and the UK have spurred further momentum, providing a window for issuers to come to market and refinance maturing capital structures at lower rates than would have been available 12 months ago.
However, the one piece of the puzzle that has yet to fall into place is M&A and buyout financing. Issuance for M&A and buyouts has improved year-on-year for both loans and bonds, but at a much slower pace than other uses of proceeds, most notably, refinancing, which has been the single biggest driver of issuance in 2024.
Dealmakers anticipate that the M&A market will start to move into a genuine period of recovery in the next 12 months. But narrowing the gap in valuation expectations between buyers and sellers remains an impediment, with vendors still reluctant to accept lower valuations for assets that fetched top dollar at the peak of the cycle in 2021.
Prediction 2: Imitation
The team anticipated that investment banks that had focused leveraged loan syndications and high yield bond issuance—having noted the success and resilience of the private debt market—would move to foster closer ties with private debt managers and launch and expand their in-house private credit capabilities.
While there has been some activity with investment banks launching and raising their own private debt funds, a newer trend of ties and partnerships between the banks and private debt managers has emerged.
In these private credit partnerships, the banks negotiate agreements with private debt managers in which the banks will originate deal opportunities that are then shared with direct lender partners who will take a large share of the transaction.
It remains to be seen how these partnerships will develop given that the established private debt franchises have built up their own origination infrastructure over several years. But the partnerships do reveal how an increasingly dynamic interplay between the banks and private debt funds is leading the industry to evolve and pursue interesting new possibilities.
Prediction 3: Creativity
Our report predicted that tight liquidity in mainstream financing markets would see dealmakers and borrowers turn to innovative financing structures and products to repurpose existing funding structures and unlock liquidity. Areas that we had forecast to be active included NAV finance and private credit CLOs.
However, the focus in 2024 tended to stay on the mainstream, with borrowers putting in the hard work to secure financing despite the tough market. The focus has been on the fundamentals of corporate credit, rather than inspired creativity.
That said, there has been a willingness to embrace new structures and sources of capital to reach liquidity. As predicted, NAV loans have been used more often to unlock liquidity, as have continuation funds. In these funds, sponsors, with the backing of a secondaries fund, will roll selected assets into new vehicles and give incumbent investors the option to either roll their stakes forward or exit with cash.
Sales of minority stakes in assets have also come to the forefront rather than control deals in a still muted M&A market. In some cases, issuers have refinanced loans and then used the proceeds to support a minority stake deal.
Portability, where companies can carry over or “port” existing debt facilities when a company’s ownership changes, has also been explored more closely. This can save buyers from having to raise new financing in a challenging market and smooth out the deal process.
Although portability has not been a common feature of loan documentation historically (in contrast to high yield where this is more common), during the past 12 months, private equity sponsors have been turning to portable debt facilities in growing numbers in an effort to support M&A transaction flow.
Although the rally in refinancing has caused demand for portability terms in documents for new loans to ease somewhat (and, concurrently, for investor pushback against such terms to increase in the absence of a specific need for portability), portability clauses do set a floor for terms on new debt and have helped to frame negotiations around refinancings.
Prediction 4: Distraction
At the start of the year, we forecast that the challenges posed by managing underperforming legacy assets and ongoing restructuring efforts could divert resources from new opportunities, with bandwidth consumed by liability management exercises and amend-and-extend deals.
Regarding underperformance, defaults have indeed edged higher through 2024, but remain in the single digits and have not been as problematic as some feared. S&P reported a default rate for speculative grade debt of 4.7% for the 12 months through June 2024, and projected that this will come down to 4.25% by the end of June 2025.
Lower than anticipated defaults have eased the strain on issuer and lender resources. Issuers have also been more proactive at taking initiative earlier, making the process of managing stressed credits easier to deal with rather than dealing with a freefall credit.
But even though there has been a “soft landing” for European debt markets, amend-and-extend deals have absorbed some resources, and stakeholders have also had to monitor the first US-style liability management transactions in Europe, which presents both challenges and opportunities.
The ultimate impact of the emergence of liability management deals in Europe is not yet clear, but the development has absorbed resources as the market works through what the implications of these deals could be for lenders and borrowers.
Prediction 5: Optimism
Our report projected that European debt markets in 2024 would feel a growing sense of optimism as interest rates began to come down, making it easier to price risk, provide clarity on financing costs, and allow markets to shift focus from managing downside risk to looking for upside opportunity.
So far, 2024 has been better than 2023. Interest rates have come down as anticipated and overall issuance has improved, with refinancing particularly busy as numerous issuers have come to market to refinance at lower rates.
As mentioned previously, the M&A market has yet to fully rebound, although signs of deal activity igniting did flicker in the summer with the announcement of some large corporate carve-outs and take-privates.
There has been a lingering sense of downside risk, most notably around the impact that major geopolitical events could have on the markets if conflicts escalate. But, overall, the mood has definitely brightened as the year has progressed.