The US leveraged finance market ended 2022 in the red as inflation and rising interest rates dampened issuance
The U.S. leveraged loan and high-yield bond markets saw a significant drop in issuance in 2022, as macroeconomic and geopolitical uncertainty drove up borrowing costs, dampened risk appetite and significantly reduced M&A activity.
Leveraged loan issuance was US$1.1 trillion in 2022, down 24% from the US$1.4 trillion reached in the 2021 bull market. Americans displayed in 2021.
Global issue in value 2019 – 2022
Device type: High yield bonds and leveraged loans Use of profits: All
Location: UNITED STATES Sectors: All sectors
Inflation and rising interest rates are taking their toll
Soaring inflation and rising interest rates have had a direct impact on leveraged financial markets, with a rapid decline in new issuance not seen since the 2008 financial crisis.
After a steady stream of hikes throughout the year, the benchmark interest rate climbed again in December to end 2022 in a range of 4.25% to 4.5% – the highest levels seen in 15 years – as the US Federal Reserve acted aggressively to keep a lid on the worst inflation the US has seen since the 1980s.
Rising interest rates pushed up borrowing costs in 2022, with the weighted average margin for institutional loans in the primary market peaking at 4.97% in the third quarter before falling back to 4.24% at the end of the month. year (versus less than 4% at the start of 2022), according to By debts.
Rising borrowing costs also halted the opportunistic refinancings that accounted for a large percentage of market activity in 2021 and deterred new issuers from entering the market unless absolutely necessary. Investor appetite for refinances and new deals has also waned, with lenders preferring to buy existing paper at deep discounts rather than supporting the scarce supply of new deals.
According By debts, leveraged loans in the secondary market averaged 91.49% at par at the end of 2022, down from 97.72% at the start of 2022. In the high yield market, yields in the secondary market have averaged from 4.42% in January 2022 to 8.4% in December after reaching 9.5% in October.
LBO and M&A show slips
Higher borrowing costs and bargain prices in secondary markets combined to reduce appetite for M&A and buyout issues, which weighed on year-on-year numbers. another, with traders refraining from entering into new deals to gauge the fallout from broader macroeconomic uncertainty.
Loan issuance for buyouts and M&As fell 34% from US$453.2 billion in 2021 to US$297.2 billion in 2022, with high-yield activity falling from 88. US$4 billion to US$31 billion, down 65%.
As the year wore on, private equity dealmakers in particular found it increasingly difficult to secure financing for deals as underwriting banks all but closed shop after taking d significant write-downs on loans they were unable to syndicate to investors. According Bloomberg, banks are still sitting on nearly US$40 billion in these “locked-up deals,” freezing their balance sheets and limiting their appetite to write new deals.
The lack of activity in the syndicated loan and high yield bond markets, however, has created an opportunity for direct lenders to fill the void and win giant deals that would otherwise have been funded in the institutional markets. Examples include a consortium of direct lenders led by Blackstone Credit providing US$5 billion to finance the takeover of software company Zendesk and a US$4.5 billion package provided by Blackstone Credit and Ares, among others, to fund an agreement for information resources.
Some direct lenders also acted opportunistically in seeking to buy up debt that banks were struggling to syndicate. Private market manager Apollo, for example, has raised more than US$2 billion to buy debt that banks have been unable to syndicate from institutional investors.
The light at the end of the tunnel
As 2023 approaches, market conditions remain challenging. The Federal Reserve has signaled that further rate hikes are on the horizon and no cuts are expected until 2024 at the earliest. US economic growth is expected to be tepid and M&A markets remain moribund.
Sustained high interest rates should also begin to impact existing credit, with increased risk of default and distress. According to Fitch Ratings, the outlook for defaults in the United States is rising, with the rating agency expecting institutional loan defaults to be between 2% and 3% and high-yield bond defaults between 2.5% and 3.5%.
However, some early signs of a general market recovery are emerging. In January, the US Bureau of Labor Statistics reported that inflation was 6.5% in December. Although still above the Federal Reserve’s 2% target, the December figure marked the sixth consecutive monthly decline and the lowest level since October 2021.
Slowing inflation appeared to be a factor in improving investor appetite for the syndicated loan and high yield bond markets in late 2022. Leveraged finance activity picked up recovered somewhat in December, with a group of operations crossing the line. Prices also showed signs of improvement in the fourth quarter of 2022, with borrowing costs declining from the peak recorded in the third quarter.
Turbulence may yet be ahead and, after a difficult 12 months, lenders and borrowers are hoping for calmer waters after the storm.