Macroeconomic headwinds buffeting the market are persisting – inflation remains sticky, the Federal Reserve is expected to keep on aggressively hiking rates, and global volatility and supply-chain constraints stemming from the coronavirus (COVID-19) pandemic and Russia’s ongoing war in Ukraine continue unabated – manifesting in debt markets largely shutting down. With many investors choosing to sell out of holdings in the face of slumping prices and a potential recession looming, US sponsored term-loan secondary market prices have tumbled over seven points this year to 90.97, adding to downward pressure on the market.
The price is not right: record high pricing in primary market hinders new issuance
Another dynamic keeping borrowers sidelined of late is historically high pricing in the primary market. At 540 basis points (bps) in the third quarter, the weighted average bid on first-lien institutional loans backing buyout activity reached its highest level since 2016. Cardenas Markets priced the highest-margin first-lien loan of the quarter with its USD 435m TLB due 2029. The facility, supporting the company's secondary buyout by Apollo Global Management, priced at the secured overnight financing rate (SOFR) + 675bps, with a 75bps floor and 94 original issue discount (OID). As has been the case for much of the year, committed financings have dominated the primary landscape, as any issuers who can wait out the current pricing environment remain sidelined, with buyouts accounting for 77% of institutional loan issuance in September.
Issuers have also been forced to offer steep discounts on new loans to entice investors who could otherwise find comparable yield in the secondary market. With secondary prices depressed, the average OID on new leveraged buyout (LBO) loan issuance soared to 91.87, or an average discount of 813bps, up from only 111bps in the first quarter. BBB Industries offered the steepest discount of the quarter at 1,000bps on its USD 1.225bn TLB to support its secondary buyout (SBO) by Clearlake Capital.
Lastly, with interest rates rising, inter-bank lending costs have also been creeping upward, as demonstrated by the average three-month SOFR surging to 2.5% in September from only 0.05% in January. The combined effect has been record-high yields in the loan market, topping 10.60% in the third quarter from 5.20% in the first quarter. With a recession on the horizon, and cash flows and credit health in question, it could be a tough price to pay to access capital for many borrowers.
Down and out: last year’s expectation of explosion in buyout activity evaporates
Record leveraged loan and high-yield bond issuance in 2021 supported buyout activity, with loans racking up USD 166.9bn and bonds supporting USD 27.6bn of buyout issuance for the year. However, it’s a different story in 2022, with those figures falling to USD 84.0bn and USD 13.8bn, respectively, through the third quarter, marking declines of 36% and 47% from year-ago volumes.
Many companies shelved plans for acquisitions and buyouts at the height of the pandemic in 2020, leading to a bursting pipeline of deals in 2021, when approximately USD 2.6trn of M&A activity was announced, according to Mergermarket. This has halved to USD 1.3trn in 2022 year-to-date (YTD), as macroeconomic conditions soured, and companies have once again been forced to reconsider transformative deals until the market can better support them.
Following a first quarter that showed promise of another year of high buyout financing volumes (USD 47bn of loans and USD 7.4bn of bonds – more than half of the YTD totals), the outbreak of war in Ukraine and sharp rise in interest rates to combat inflation have since held back activity. Just last week, the sale process for Gerson Lehrman Group stalled, as bids for the SFW Capital Partners-backed company did not meet the vendor’s valuation expectations of USD 3bn. This has been a common story in recent months, as banks struggle to offload risky buyout debt and in turn ask that buyers over-equitize to get deals across the finish line.
In the primary market, Brightspeed saw its USD 3.9bn loan and bond financing pulled after failing to generate enough demand from investors, while upcoming syndications, including Nielsen Holdings’ take-private financing, could face delays amid the market downturn.
