November 2017

Following a multi-year post-crisis slowdown, the leveraged finance market in Europe turned a corner in 2013 and has recently gathered significant momentum, notes Deutsche Bank’s Munish Singla. 2017 is likely to see the highest loan issuance volume since the heydays of 2007

New issuances for the year ending 31 October 2017 stood at EUR 95bn, already close to or higher than the full year levels since 2007. The second half of 2017 has seen a particularly heightened level of activity in continental Europe with yields declining from 4.5% to 3.0% over a 12-month period. The largest European economies of UK, Germany and France represent close to half of the issuer volumes.

This recovery has been broad-based, led by financial sponsor and corporate activity across leveraged buyouts (LBO), acquisitions, re-financings, and re-capitalisations. Underpinning this recovery are the twin drivers of improving economic fundamentals and investor search for yields given historically low-interest rates and the ECB’s ongoing quantitative easing program. 

Markets have adopted a bullish stance underpinned by strong and improving fundamentals. Consequently, heightened equity valuations are providing an impetus for corporates to raise debt to finance capital investments or engage in M&A. Meanwhile financial sponsors continue to access the high yield market to raise LBO financing. Additionally, borrowers are refinancing to lock in lower rates while there is risk appetite in the market.

From the investor perspective, the high yield market remains attractive. It is already well established that the post-crisis record low interest rates and quantitative easing measures implemented by the ECB have pushed real-money and other institutional investors further up the risk curve in search of yield. The ECB path towards gradual tapering and eventual normalization is likely to allow the market to maintain its stride. While the timing and eventual path of normalization is not yet clear, we foresee macro and financial conditions being supportive of issuance across the high yield spectrum in the medium term.

In addition to traditional loan and debt instruments, the leverage finance market is enjoying further support from rising CLO issuance. Since the start of 2017, European markets have seen a about EUR13bn of CLO issuance which has been bolstered by the expanded participation of pension and real money funds looking for better returns.

The aforementioned factors of higher growth, low yields and growing CLO markets have been supportive of the leverage finance sector thus far.

However, investors should remain vigilant of potential risks. Some industry observers are beginning to caution of potential borrower stress should the interest rates rise earlier or at a faster clip than priced-in expectations. Given the nature of high leverage transactions, small changes in interest rates could materially alter debt service capability of the borrowers. Continued momentum on economic growth and “lower for longer” interest rates will be key. However, the real test will be the specific transaction fundamentals. Investors should keep the macro as well as deal-specific factors in mind.

Munish Singla is Global Head of Deutsche Bank’s Escrow Solutions business within Trust & Agency Services.

Deutsche Bank’s Trust & Agency Services in London is committed to helping clients to navigate markets and opportunities through a range of trustee, agency and escrow services. 

For example, in a typical transaction we would provide a one stop offering across the debt solutions. In addition to administering the loan and bonds Deutsche Bank can also support an escrow for the bond proceeds, which can be invested in a diverse range of triple A-rated liquid instruments including money market funds from top tier providers. A portion of these funds can also be held on the balance sheet to minimize any execution and operation risk.

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