A tale of two markets
Multiple market indicators point to a late cycle credit market, including:
- Macroeconomic indicators such as consumer spending; sentiment and capital goods; ongoing slowing of German and other key economic areas’ industrial production
- Substantially increased bifurcation of credit quality, and deal completion – demonstrated by increased pulled deals and hung syndications
- There has even been marginal reduction in new issue leverage and some spread widening on new issues, indicating an acknowledgement that risk has been too cheap for too long
However, the overwhelming driver of credit availability, and asset prices, in recent years has been central bank behaviour – both directly in rates and more indirectly through QE. Despite Draghi attestations that European Central Bank (ECB) would someday stop or at least slow its expansionary monetary policy, that banks needed to get their houses in order and that governments needed to enact more supply-side reforms, his swansong apparently reflects a mean reversion of more easy money.
The arrival of Lagarde at the ECB has also been important. The first appointment of a politician rather than an academic appears a subtle yet tacit acknowledgement of what investors have suspected about fiat currencies. In the UK, the Brexit suspense is slowing, giving way to fatigue and resigned acceptance as the risk of a no-deal Brexit recedes. Again, though, the Bank of England has signalled willing support for easing and the deal flow continues relatively unabated.
In the mid-market, this tale of two markets is reflected in a number of ways. Deals are still getting done but taking considerably longer and requiring greater tenacity in placement and tougher negotiation to the finish line. While the market share of direct lending funds (both in the mid-market and more generally) continues to increase, funds are exercising more scrutiny on investments. Further, DC Advisory is seeing an increased mix of amendments and covenant resets, as well as refinancings that may result in amend and extends rather than normal third party deals. This environment means borrowers, more than ever, need the Right Advice to navigate increasingly challenging refinancings.
Finally, there is a marginal shift in the fundraising mix from direct lending to more alternative credit solution funds (e.g. special situations, distressed, credit opportunities, etc.), but fundraising itself remains strong.
Percentage of deals accounted for by LBO transactions per region
- Overall deal volume was down in Q3 reflecting the natural summer slowdown, although still ahead of the same period last year
- In Q3, there has been a clear change in credit appetite and increased caution as the market anticipates that we are at or near the top of the cycle. Brexit apathy and fatigue have been overshadowed by more fundamental political and economic concerns that could lead the economy into recessionary conditions
- Whilst resilient credits still achieved strong multiples and looser terms, challenged credits need more careful management. Those lenders with the flexibility to price risk along the credit risk curve have been the busiest
Types of refinancing by structure (UK)
As has been the case for some time, direct lenders dominate the lender landscape, reflecting the growing prevalence of unitranche structures, utilised in the majority of deals in Q3.
- Increased competition between private debt funds for top quality mid market assets has led to a continued borrower-friendly financing environment
- Despite their declining market share, French commercial banks still play a key role in the lending space despite, notably by offering competitive blended pricings on all senior financings including private debt fund structures
Deal split per quarter (France)
Leveraged financing volumes picked up in Q3 following a slow start to the year driven by a surge in M&A activity with 23 deals completing.
- DACH mid-cap leveraged lending activity has improved q-o-q with 28 transactions in Q3 19 vs. 21 in the prior quarter. However, YTD volumes are down in comparison to 2018 and this is expected to remain the case to the year-end
- Direct lending funds continue to dominate, sustaining their market leading position with some senior banks beginning to deliberately scale down business
Issue volume per deal type (DACH region)
Increased volumes have been driven by recent M&A activity, with LBOs accounting for two-thirds of deal flow in Q3.
- The Spanish leveraged loan market continues to grow, with several notable refinancing transactions such as Parques Reunidos, Áreas, Cepsa or Pepe Jeans, supported by large underwriting appetite
- The top three Spanish banks continue to dominate activity, remaining the main financing source domestically. Debt funds are consolidating their position in the market, with a growing presence in sponsorless transactions
Number of deals per quarter (Spain)
Since a trough in activity at the end of 2018, Spain has seen a continued increase in leveraged loan activity in 2019.