Photo: thomas hawk via Flickr
With the market largely shut down now for the holiday break, 2011 leveraged finance volume stands at $591 billion, the most since the all-time high of $679 billion in 2007, and up 13% from the full-year total of $521 billion in 2010.Loan issuance drove the increase, rising 60%, to a post-2007 high of $372 billion. High-yield volume, by contrast, fell 24%, to $218 billion, from a record $287 billion in 2010.
As these numbers suggest, the share of loans in the overall leveraged finance pie expanded to a three-year high of 63% in 2011, from 45% in 2010 and a record-low 32% in 2009.
Loans were ascendant in 2011 for two main reasons: (1) surging loan refinancing/repricing in the first half, and (2) fading bond-for-loan takeout volume. In the first half, issuers took advantage of strong technical conditions to refinance $67 billion of loans, the biggest spread-cutting bonanza since first half of 2007. For 2011 as a whole, loan refinancing accounted for 30% of overall volume, or $70 billion, up from $5 billion, or 3.2%, last year.
While loan-for-loan refinancings waxed, bond takeouts waned, dropping to $43 billion in 2011 (as of Dec. 19), from $116 billion in 2010. Arrangers say the decline is largely a result of shrinking near-term maturities. At the end of 2009, issuers had $415 billion of institutional loan maturities due by the end of 2014. By year-end 2010, the comparable amount of maturities was $263 billion. As 2011 draws to a close, the numbers is even lower, at $146 billion, suggesting bond takeout volume may well slide further in the year ahead.
Excluding these pure financing trades, loans’ share was little changed in 2011. Take M&A-related financing. Issuers tapped the leveraged finance market for $177 billion of financing to back acquisitions, a 30% increase from 2010. Loans accounted for 70% of that total, or $124 billion, versus 62% in 2010.
Dividend financing – the other main source of new-money deal flow – rose 7% in 2011, to a record $57 billion. Loans’ share of the total, however, slipped to 64%, or $36.5 billion, from 69% the prior year, or $36.8 billion. Dividend-related bond volume, by contrast, rose 26% in 2011, to a record $20.4 billion.
Volume across the leveraged finance market rebounded somewhat in the fourth quarter, rising to $94 billion, from a seven-quarter low of $79 billion in the third quarter. Of course, this figure pales beside that of the first half, when liquidity was flowing and volume soared to a $418 billion, putting the market on record pace before the second-half slowdown.
High-yield volume saw a better bounce in the fourth quarter than did loan volume. Indeed, high-yield activity expanded 44% from the third quarter, to $35 billion. Loan volume, meanwhile, was up just 9%, to $59 billion.
The reason is largely explained by the drop in M&A-related volume during the final stretch of 2011. After suffering through a slew of third-quarter syndications for loans that were structured prior to the summer swoon – some of which may have cleared outside of fees – arrangers tightened the reins on underwriting in the second half. As a result, volume shifted away from M&A, with overall leveraged financing in this loan-rich segment dropping to $37.8 billion between October and December, from $40.2 billion in the third quarter.
The pattern is similar for dividend deal-flow, where volume downshifted to $2.3 billion and $2.5 billion in the third and fourth quarters, respectively, from $25 billion in the first quarter and $27.1 billion in the second quarter.
It has become a cliché to say that the 2012 outlook boils down to one word: Europe, an example of a “known unknown” if there ever was one. While waiting and watching, participants continue to play a “prevent” defence that likely will limit activity for the foreseeable future.
Private equity firms, for instance, are reluctant to either releverage seasoned properties via dividends or embark on new LBOs. In the former case, participants say that sponsors are reticent to pile additional leverage on portfolio properties during what could prove to be the calm before the storm. That doesn’t mean there will be no new dividends in the first quarter. But until the economic outlook is clearer, participants expect that the re-leveraging exercises that emerge when the window opens will be for defensive companies with significantly deleveraged balance sheets. PE firms are taking a similar stance on new LBOs.
After all, modelling future cash flows is terribly difficult today, for obvious reasons. Moreover, when it comes to new deals, PE firms are in some sense stuck between a rock and a hard place. On the one hand, executing public-to-private deals that tend to require long lead times has grown more difficult, what with under writings more challenging. On the other hand, sponsor-to-sponsor deals are out of favour among limited partners, which see little value in re-trading a property from one fund to another (in some cases with the same participants in the funds of both the seller and buyer). Therefore, LPs are pushing back on capital calls to fund such deals, sources say.
Arrangers, too, are cautious, underwriting only conservative deals, and even then, fortifying commitments with wide flex caps. Finally, as the inflow numbers for loan and high-yield funds suggest, investors aren’t anxious to put the risk trade back on.
All told, leveraged finance is likely to have a bumpy ride in early 2012, rocking with refinancings and other opportunistic trades when sentiment is strong and slumping when the news is downcast.