The leveraged loan market faces new challenges and new opportunities in 2011. The past 12 months have shown encouraging signs of growth and recovery, but with new regulations and accounting changes on the horizon, there is continuing uncertainty. The Basel proposals are highly complex and will have an impact on both capital and liquidity requirements for financial institutions.
Global economic growth in 2010 was stronger than most economists predicted. One of the key changes in the leveraged market in 2010 was a shifting of M&A-type activity from refinancings to new financings. According to data from Standard & Poor's Leverage Commentary and Data division (LCD), 54% of loan issuance was for acquisition-related funding (to the end of October 2010) – up from 32% in 2009. Refinancing activity declined from 62% of deals in the same period in 2009, to 43% of deals in 2010.
Generally speaking, volumes in the leveraged finance market were up in 2010 compared to the same period in 2009. According to LCD, leveraged loan market volumes in 2010 (from January to October) were valued at €30.4 billion, a considerable increase on the €13 billion for the same period in 2009.
The leveraged finance market has not just sought debt from financial institutions - there has been a marked increase in the use of the high-yield bond market. Companies have looked to this market for funding to tackle both the refinancing risk that they are facing over the next few years and to bridge any funding gaps. Private equity firms have also been more active in the bond market in 2010 than in the past. For example, Bridgepoint used the senior secured bond market to fund the acquisition of Care UK Health & Social Care Newco Limited in July 2010 (with £240 million of senior secured bonds and an £80 million super senior revolver).
Refinancing risk currently remains high. Standard & Poor's estimate is that the institutional investor market holds approximately 50% of the leverage loan debt issued during the boom years in 2003 – 2007. Given the tenors of loans entered into, the total to be refinanced between now and 2017 could be as high as €300 billion across Europe.
Many private equity portfolio companies that were acquired in the "boom years" are beginning to grow again and generate cash, hence helping with the refinancing risk. Other companies will look to secondary buy-outs or 'amend and extend' transactions to deal with refinancing risks. Obviously, a number of highly-leveraged LBOs will still be at risk of restructurings and debt write-downs. However, if private equity firms are pro-active and work with lenders to devise recovery plans and give them more options either to make acquisitions (to diversify the portfolio) or to divest certain assets.
While companies and private equity firms may view it as attractive to delay refinancing and continue to pay the lower rates agreed during the credit bubble, institutional investors may be more receptive to companies seeking to refinance early.
There are also a number of initiatives in the market working on removing some of the barriers to entry that non-bank investors face with a view to increasing liquidity in the leveraged loan market.
While both economic and funding risks in the leveraged market are likely to remain, there appears to be real appetite amongst private equity firms to invest. With this increased appetite for investment and therefore for funding, there is real scope for innovative debt solutions.