Monday, November 25, 2013

Leveraged Finance: Best of Times?

Regulators are concerned with the state of credit markets, in general, and the leveraged loan (LL) market, in particular (see Regulators). Market states are driven by changes in investor risk appetite. Rising wealth from the post crisis bull market is fueling increased risk appetite. This, combined with a search for yield in a low interest rate environment, underlies the resurgence of leveraged financing.

This is especially notable in the return of the collateralized loan obligation CLO market. This market shut down during the crisis due to unexpected losses from step market price declines. The activity returned in 2012. CLO investors are the major LL investor base. Their return underlies the spike in 2013 leveraged activity. Note the following:

1)        LBO activity has ballooned this year.
2)        Funded debt multiples of EBITDA have returned to near pre-crisis levels 5.5X v 6.2X.
3)        Purchase price multiples are increasing.
4)        Percentage of contributed equity in LBOs is falling to 32% - near the pre-crisis low.
5)        Financing structures have changed. Balloon based term loan B’s have replaced amortizing term loan A’s.
6)        Loan spreads have fallen to pre-crisis levels. They fell 100BP alone from 2012 levels.
7)        Return of aggressive pre-crisis instruments like Payment-in-Kind-Toggle PIK-T and covenant-lite   loans Cov-lite. In fact, cov-lite now represents a record 52% of LL  issuance.
8)        Surge in higher risk transactions including Public-to-Private (PTP) and Leveraged Recapitalizations (LevR). PTP is at its highest level since the pre-crisis 2007 peak, while LevR have reached record levels.
9)        CLOs issuance for 9 months 2013 is  $57B v $30B for same period 2013.

For issuers it is the return of the good times in terms of funding availability, structure and flexibility. Just because you can do something, however, does not mean you should do it. We are likely to see to higher priced and over leveraged transactions going forward. Yield chasing investors are likely to suffer disappointing pro forma returns once risk appetite peaks and market liquidity falls. We cannot predict when this correction occurs. We can, however, predict that it is closer than where it was at the beginning of 2013.


PS We are approaching the next offering of our Acquisition Finance Course in Amsterdam and that also means approaching the deadline to sign up. Hope to see you in Amsterdam - one of our favorite cities!

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