2015 was a story of two differing halves. The first half saw adequate financing markets availability of debt capital for leveraged borrowers. The second half was more volatile, with debt capital becoming more scarce and overall issuance declining.
For the year as a whole, total new money lending volume in the U.S. approached record levels, largely driven by M&A related financings, but that activity was mostly concentrated in the investment grade space. High purchase price multiples and lower quantums of available debt helped constrict sponsor-backed LBO deal flow, which declined dramatically from previous years in spite of a robust overall M&A market and, in particular, a boom in mega-deals. The relative strength in the investment grade financing market was reflected in overall loan ratings, which achieved multi-year highs.
The leveraged loan market was considerably weaker, especially during the second half of the year, with a sharp decline in LBO activity by private equity sponsors. LBO transactions faced new pressures—most notably, the 2013 federal interagency leveraged lending guidance (primarily with respect to its general admonition against debt-to-EBITDA ratios in excess of 6:1) appears to have influenced the market. We previously discussed this lending guidance in greater detail in our February 2015 issue of the Private Equity Digest (see here). Lenders are widely reported to have decreased their appetite for highly leveraged deals and the number of deals with leverage multiples above the 6:1 threshold decreased markedly in 2015.
Riskier segments of the leveraged loan market were particularly hard hit. Second lien loan issuance, for example, plummeted to the lowest levels in several years. Lower rated issuers, and entire industry sectors (including energy and retail), faced challenging conditions in financing deals.
“Flex” rights (allowing modification of committed financing terms) expanded over the course of the year. More and more financing arrangers insisted on increased flexibility to modify pricing and deal structure, impose financial maintenance covenants and otherwise tighten the financing terms in order to mitigate the risk of undersubscribed syndications. On the other hand, some borrower-friendly trends that emerged over the past several years persisted in the market. Covenant-lite loans made up a greater share of the market than ever before, representing nearly three-quarters of institutional loan issuance in the large corporate market. In addition, in documenting loan commitments and the definitive agreements, large sponsors often continued to hold the power of the pen and negotiate extensive details of the financing terms upfront during the commitment stage. Both of these features also continued to trickle down deeper into the middle market during 2015.
As we begin 2016, market forces and macroeconomic factors continue to shape the dynamic and increasingly volatile financial markets. It remains important to keep a finger on the pulse of the markets to successfully navigate the shifting landscape.
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