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Fin Strathern

Laura Thompson

How is the leveraged loan pipeline shaping up for the remainder of the year?

We talked to Daniel Rudnicki Schlumberger, head of leveraged finance EMEA at JPMorgan Chase & Co., about the competition between private credit and high yield, refinancings, and the increase in direct lenders looking at syndicated deals.

1. Some private credit investors have told us they are seeing opportunities for sponsorless investments away from traditional bank debt today. Is this something you are seeing?

The sponsorless business represents about 50% of the market today for term loan Bs and high-yield bonds, and that percentage has been growing year after year. On the private credit side, there is growing interest for sponsorless transactions, but the development of this type of transaction is still very much in its early innings, they're currently fairly infrequent.

We see the most sophisticated borrowers being fairly agnostic and looking case-by-case at what is the best financing route. Cost is involved, of course, and whereas last year, private credit was clearly cheaper, this year there's much more of an even playing field. High yield bonds are the cheapest financing option at the moment because of the inverted curve. It is rare to see EURIBOR being materially more expensive than the five-year swap rate.

That doesn't mean that HY is the right solution for every borrower. Some dislike the disclosure obligations of a high yield bond. Some borrowers prefer widely syndicated loans to a private instrument because they like that debt to be widely distributed. They feel uncomfortable with having a highly concentrated syndicate of lenders. Others may decide that direct lending provides more leverage or an easier execution in certain situations. The discussion now is very much case-by-case and very company-specific. It's much more of an even playing field than last year.

2. The rise of direct lenders and the private credit market chipping away at liquid loans was a big theme — and concern, for some — last year. How has this year shaped up?

For new transactions, the direction of travel was overwhelmingly towards more direct lending last year. This year it's a much more interesting and complex idiosyncratic discussion with no clear trend.

Very relevant is where you are starting from. If you have an existing setup in high yield or a syndicate of term loan B lenders, quite naturally, keeping it in place will be the path of least resistance.

An underwritten financing can provide certainty, speed, and confidentiality. This is the reason why Silverlake decided to work with us to finance the take-private of Software AG with a TLB that we underwrote. Doing so allowed them to keep a very price sensitive transaction confidential up until the day of announcement.

3. What’s been driving this more even playing field?

Today, the single B euro HY index is yielding 8.2%. Let's say you're a standard single B issuer and you pay a little bit of new issue premium so you're pricing a high yield bond at 8.5%.

That's quite a bit cheaper than a direct lending deal. Today’s EURIBOR rate is 3.8%. If you take the usual direct lending spread of say 6.25%, you're already at 10%. Add to that an OID of say two points taken off on top and you’re in the low teens.

So the difference in pricing between high yield and direct lending today is reasonably large — as it should be. An illiquid instrument should be yielding more for its investors. But it's a very, very different situation from last year, where at its widest the single B euro high yield index was 10.25% and the 3-month EURIBOR was 1.5%.

At the same time, we're completely agnostic as we offer all three products (syndicated loans, high yield and private credit). We've got a great direct lending offer that has been set up and already deployed capital in a number of transactions in Europe. We are getting great reception from our clients who are pleased to have a direct lending financing structure with a relationship bank.

4. How do you think the market can progress from the current gridlocks in activity due to valuation disagreements between buyers and sellers?

The market is moving — it may not be going particularly fast, but nevertheless we have started seeing more auctions this summer and more inquiries from sponsors and corporates looking to sell assets. We're hopeful that towards the end of the year and beyond, the auction flow and volume will pick up.

Now, that's not going to help in the short-term when it comes to market volume and issuance volumes. September is looking like a reasonably slow month M&A wise, but we're expecting continued activity in the TL and the high-yield markets driven by A&Es, maturity extensions, and refinancings.

We started the year with about €200bn of high-yield and leveraged loans that needed to be refinanced because they were maturing in 2023, 2024, 2025. That number is now down to €150bn, which is still material. A lot has been done… but there's still quite a lot to do.

We are also expecting to see more dividend recapitalisations. Our markets are very much open for dividend deals. We've led 12 out of the 15 dividend recapitalisations that have been done year-to-date in Europe. So… more of the same for September and October.

5. We hear complaints of A&Es not being the most thrilling deals for an investor to look at. What makes a complicated A&E?

When it's not just about the debt. The reality today is that there are great companies that are performing well, that had finely tuned capital structures for an environment where debt costs 3.5%. When debt costs 8.5% percent, the capital structure just doesn't work.

This means you've got to do other things, as part of an A&E, like M&A. Some of these transactions will require an equity injection or some subordinated capital.

One very interesting transaction we did was for a great company called Oatly. It’s a Swedish company that produces oat milk. For that one, we had to extend the RCF, raised a new secured term loan B, did a first-time issuance in dollars, and issued equity.

These complex transactions, including multiple executions, are particularly interesting. A&E is one of the tools used in a holistic solution. These complex holistic transactions are JPMorgan’s specialty and allow us to showcase our broad product capability.

6. What else do syndicated loan and high yield investors have to look forward to in 2023?

The syndicated loan market right now is in very good shape. CLO creation has been good. After a bit of a lull in June, we had ten new CLOs created in July and August. More are being prepared. These CLOs have been turning to the secondary market to ramp up, which is supporting secondary market prices. The technicals of the leveraged loan market seem excellent for September.

We're not seeing how that demand is going to be met by new issue volume. These conditions are simply the best leveraged loan market we've had in 18 months so it's a great prerequisite for new transactions including M&A-related ones.

7. If you had to estimate the size of the leverage loan pipeline for the remainder of the year, what figure would you put on it?

From what’s visible, I would say for the rest of the year the pipeline will be less than €5bn in European leveraged loans and a good share of that is going to be in refinancings.

That said, long term uncertainties remain material. Volatility will come back at some point. We advise our clients to take this window if they need to refinance.

8. Do you think we're going to see more direct lenders on syndicated deals moving forward?

Yes, we think these markets are going to continue to converge and we're going to see more managers and funds looking at both types of assets.

9. And for something more personal, we hear that you started your career in a rather different place than the JPMorgan grad scheme?

I actually started my career in politics. I’m really glad I did so when I was 23 because I realised early on that it wasn't for me. That said, I met my wife there, so it wasn't a loss! In a way, it's similar to finance because in these sorts of jobs you've got to interest yourself in a wide range of problems and human activities to get the most out of them.

9Questions — Daniel Rudnicki Schlumberger, JPMorgan — Down the pipeline

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