Leveraged finance market participants say they are optimistic that new leveraged buyout deal-making will pick up in 2024, amid a year with anticipated interest rate cuts. Still, many do not expect volumes to return to the higher levels of years past, according to dealmakers and investors surveyed by Reorg.
This winter marked the two-year anniversary of Russia’s invasion of Ukraine, as well as the debut of the Fed’s policy to increase federal fund rates, both of which resulted in an effective freeze on LBO activity, the market sources said.
This year, however, as dealmaking has begun to flow, the once-clogged pipeline of so-called hung deals has nearly cleared - an exception being Elon Musk’s purchase of X Corp., formerly known as Twitter, as well as a portion of debt financing Apollo’s purchase of car part supplier Tenneco.
Yet volatility did not deter a few new LBO deals from forming in the past year:
Syneos Health and
Worldpay both printed billions of dollars in bonds and loans to finance their respective buyouts by an Elliott-led group and GTCR late in 2023. And deals such as
Cotiviti and
Kohler Energy, which financed their KKR and Platinum Equity buyouts, respectively, have indicated that the market has snapped back. Participants have offerings in the pipeline to look forward to as well, such as
VMware’s end-user computing business from Broadcom to finance its buyout by KKR.
Poised to Recover
Recent deals have spurred interest in buyout deal-making once again, and leveraged finance market participants say positive economic conditions have also added to the resurgence of activity.
“The past period of rising rates created some pain in the market,” said David Rosenberg, head of liquid performing credit and co-portfolio manager of U.S. high-yield bond strategy at Oaktree Capital. “But conditions feel better now, fundamentally, regardless of whatever landing we have.”
As a result, participants predict the three markets - high-yield bonds, leveraged loans and private credit - will continue to perform. Leveraged loan issuance in the U.S. has skyrocketed to start the year, totaling $108.9 billion in January and February this year, compared with $56.17 billion in the same period last year, according to
Pitchbook/LCD data. Meanwhile, high-yield bond issuance in the U.S. has also picked up to start the year, totaling $49.98 billion in January and February this year, compared with $35.04 billion in the same period last year, according to
Pitchbook/LCD data.
“High-yield is reemerging from a two year sleep,” said Andrzej Skiba, managing director and head of U.S. fixed income at RBC Global Asset Management. “We’ll still see leveraged loans and private credit continue to grow.”
Laura Holson, managing director and COO of credit at New Mountain Capital, suspects that banks’ more risk-on behavior is a precursor of deal activity. “Private equity firms have dry powder to put to work and have to return capital to LPs - so the financing markets being more open will help with more M&A activity,” she affirmed.
Ernst & Young-Parthenon
recently reported that U.S. private equity M&A activity is poised for a gradual recovery this year, predicting a 13% increase in volume in 2024 compared with last year. However, the firm noted that this forecasted uptick would still leave U.S. private equity M&A activity roughly 8% below 2022’s levels and 18% below 2021’s peak.
Similarly, Logan Nicholson, managing director and portfolio manager of diversified direct lending at Blue Owl Capital, observed that after the past two years of “uncertainties relating to geopolitical and macroeconomic factors, which has driven sponsors to hold onto their assets and be patient,” he now expects a “gradual acceleration of M&A and LBO activity this year, though it may take a while to form.”
Nicholson foresees that stabilizing interest rates will provide more certainty for companies’ capital structures to borrow, making valuations more supportive of M&A activity. He added that the CLO market will be a driver of demand for transactions as well. All indicators from the CLO market point to huge demand for loans. There was $20.2 billion of US CLO supply in February, the second-busiest month ever for the market, second only to November 2021, when there was $25.6 billion of issuance,
as reported.
Optimistic About a Pickup
While interest rates are expected to plateau with the Fed’s two anticipated rate cuts this year, preferences for debt packaging are evolving as well, with new LBO deals beginning to take shape.
“We saw a shift for financing LBOs in the last few years to be more of a loan heavy model, which sponsors like for more optionality,” Rosenberg said. “But now we’re seeing a shift back to including fixed rate paper as rates are expected to come down, which investors want to take advantage of.”
Additionally, participants predict that we will continue to see high-yield spreads tighten in the market. Average high-yield bond spreads currently sit at 315 bps as of March 13
, more than 50 bps tighter since the beginning of January, according to ICE BofA data.
“Spreads will compress as deals come back in and people chase quality,” said Garrett Stephen, senior managing director and co-head of origination at First Eagle Alternative Credit. He also noted the recent popularity of junior capital structures and PIK notes within the market.
Meanwhile, John McAuley, co-head of North American debt capital markets at Citi, explained that although financing is more expensive than in years past, it is widely available in both the broadly syndicated loan, or BSL, and private credit markets.
Yet the challenge market participants are facing, McAuley said, is the “lack of deal flow for new LBOs that can support less leverage with SOFR rates above 5%.” He added that it is not a surprise to see lighter LBO deal volumes, given that financing is more expensive, combined with uncertainty on target valuations, but he said he remains “optimistic that deal flow will pick up.”
Still, some dealmakers caution that potential volatility remains amid the election year, which could hinder LBO transactions, given the uncertainty of regulatory decisions for deals.
Fight for Attention
As the market has stabilized, the broadly syndicated market has become more competitive with the private credit market by offering more attractive yields, prompting a debate among participants as to which sector will lead in 2024.
“The BSL market is still fighting for attention against the private credit space,” Skiba said. “It is becoming more competitive, and rather than losing its business to private credit, deal originators are offering better terms for investors,” Skiba added, noting that the compensation for financing via private credit is less than 200 bps, which has narrowed quite a bit since
the end of 2023.
Rosenberg said that although it is natural for competition to arise among deals when there is an abundance of money that needs to be spent, he posited that the “golden age” of private credit could be in the rearview.
“Private credit has grown exponentially, so when a market grows that fast eventually you buy what you can, not what you want to,” Rosenberg said.
“Eventually, people who jumped in on the private credit wave will find themselves in trouble - you have to be right on the credit from the beginning otherwise you’re stuck to a deal,” Rosenberg noted. “Whereas in the BSL market, you have an eraser and can get out of a deal.”
Other investors argue that private credit fills a fundamental need in the market.
Nicholson countered that the success of direct lending in recent years and the breadth of its audience only bode well for the future, as the sector has proven itself as an effective financing solution. “Many PE firms have used private credit to finance deals in the last two years when other markets were less available,” Nicholson noted.
Holson shared similar sentiments on both markets. “The BSL market has reopened but certainly there is room for both the BSL and direct lending markets to succeed,” Holson observed. “The broad trend is toward direct lending because of the certainty and efficiency it provides sponsors, the confidentiality, as well as the flexibility to craft more bespoke financing solutions with relationship lenders compared to syndicated loans, which require ratings and where markets may open and close.”
BlackRock recently forecasted that private credit is expected to reach
$3.5 trillion in assets under management by 2028, compared with
$1.7 trillion as of June 2023, according to Preqin. Borrowers’ preferences for the flexibility of private credit and structural shifts in the public markets were among several of the drivers in BlackRock’s expected growth in the asset class, the firm said.
Still, leveraged finance participants say they are optimistic on having both markets open and running to support future growth and deal flow for LBOs looking ahead for the rest of the year.
“It will be even more helpful for deals to have the BSL market functioning and healthy alongside private credit,” Nicholson said.