TL;DR:

• A record-breaking €134bn of euro-denominated leveraged loans were issued in 2021, with Materials, and Healthcare the largest sectors, and a larger than usual slug of new money LBOs in the second half, expected to continue in Q1 2022
• 2021’s blockbuster year concluded with a quiet, Omicron-flavoured December. Buyside and sellside both expect supply to ebb gently in 2022, with recaps (from 2021’s outperforming sectors), as well as M&A set in motion in late 2021, driving the early pipeline
• High supply is set to meet high demand head on. For issuance, buyside still sees pent up borrowing demand from companies geared to reopening, with companies set to lean on loans rather than bonds as interest rates rise. From the other end, CLOs are set to continue printing at elevated levels (read Owen Sanderson and Michal Skypala’s 2022 outlook here)
• Buysiders are split between confidence and caution, backing either stable payments from stable credits or rallying risk assets in reopening trades
• Covid concerns are shrugged off, with buyside minds on inflation and rising interest rates, particularly if credits can continue to swallow rising costs in tandem with ongoing supply chain disruptions
• 2021 was the year of the margin ratchet (ESG ratchets notwithstanding) as outperforming credits pushed up to three stepdowns through the market, and rapidly hit softball deleveraging targets, leaving margins meagre
• Read Huw Simpson’s HY 2021 report here: ‘High Yield in 2021 – A Blockbuster Year in Review’

2021: Feed the world

2021 was a record-breaking year for European leveraged loans, with 2022 set to follow quick on its heels, according to 12 buyside and three sellside sources speaking with 9fin.

9fin records a total of €134bn euro-denominated leveraged loans issued in 2021, smashing through 2017’s previous record of €119bn (per Fitch) and doubling 2020’s €68bn. 

“It’s hard to overstate just how good this year was – for everyone,” said one buysider. “For issuers, for sponsors, for the banks, for the buyside.”

H1 2021 was the second-busiest half on record (behind 2017). This came after a slow start: an M&A drought and refi wave kept fresh supply tepid in early days. With a slew of fresh CLO supply at the tail end of 2020 all chasing new issues, this meant that in early H1, sponsors were able to drive margins down to what a second buysider lamented was “equal to the most aggressive pricing since the financial crisis”. (Clients can read more here: ‘Lev loans boom in second busiest H1 on record’).

Things turned quickly. February through April saw over €16bn of issuance each month, only slowing slightly to over €12bn each month through summer. In the face of this, the buyside complained that sheer manpower was constraining their ability to meet the deal flow deluge, sometimes rejecting deals after a cursory glance (if that), and many stepping up hiring to handle the supply wave.

Once summer passed, after a strong September, the market again slumped, with deals flexing wider and commitment deadlines extended. Buyside blamed both idiosyncratic deal risk and macro missteps. Alongside a rash of more marginal credits, deal sizes were also shrinking unattractively: 40% of October-issued deals were sub-€400m. 

Emblematically, by October, Spanish telecoms firm Masmovil had pulled its €2.2bn repricing (B1/B/BB) of an E+425 bps 2027 loan, first inked in July 2020, “due to market conditions”. (Read more here: ‘Lev loans sag in post-summer softening’).

“Buyside stepped back at the end of the year,” said one sellside source. “Credits that people were marginal on became instant no’s. People were looking for excuses to say no.” 

Many of the buysiders agreed with this, describing a pickier Q4 following a year of plenty.

This turn also pleased buysiders small and large, delivering heartier allocations for those still willing to play. H1, characterised by frantic oversubscription, left many struggling for scraps. Post-summer, buyside feasted: “What was 20% is now 50%, what was 50% is now 70%,” said a third buysider.

Ultimately, this blockbuster year ended in a sleepy December. Issuances sagged by over half compared to the previous year after the market hesitated on signs of Omicron. (“Or Omicron was a convenient excuse to delay,” remarked a second sellsider.) Even accounting for the fact that December 2020 was a surprisingly strong close thanks to the vaccine-inspired rally, 2021 still lags behind 2018 and 2019 too.

The Omicron pause ran into the looming Christmas period, where thin liquidity generally shuts the market. This year’s particular schedule, with Christmas falling on a weekend, also wiped out the surrounding weeks with employee holidays, buysiders report.

“Normally, you can still launch a deal on the 13th, but not this year,” said a fourth buysider. “People were gone and those left were busy looking for secondary opportunities or re-checking their credits for 2022 risks. No one wanted any more primary.”

“People were fatigued. After that big of a year, everyone was ready to wind down,” the first sellsider said, with the fourth buysider concurring: “People were more cautious in Q4, they didn’t need to take on new deals with the end of year coming up.”

Looking to the demand side of the equation, projections also show the CLO space maintaining its 2021 heat, with sellside research desks seeing between €30bn to €37bn of new issue printing in 2022. These strong technicals mean buysiders expect opportunistic loan refis will rush to take advantage of any space left by a slackening of new money supply. Read more here: ‘From strength to strength; CLOs in 2022’.

€4.7bn of sterling issue in 2021 (versus €4.1bn in 2020) maintained a sterling premium of 89 bps on B2 credits (versus just 19 bps in 2020), peaking in Q4 at 102 bps.

2022 Pipeline: Hurry down the chimney

2022 is slated to follow on 2021’s heels in terms of heavy dealflow, though likely not quite at the same pace. “2021 had all the carry-over of deals that couldn’t get done in 2020, which next year won’t have,” said the first sellside source.

Buyside and sellside sources alike describe a busy coming January driven by recaps and M&A deals, although a third sellside source sees next year’s January as “lighter” than this one, in which €6.4bn launched. 

Two buysiders flagged “a number of” M&A deals, whose issuers had the luxury of flexibility, pushed back to Q1 from early December. Two more buyside sources named German software firm Autoform and True Potential (following its September 2021 purchase by Cinven) as upcoming issuers.

Other companies are waiting in the wings for the long-anticipated Morrisons deal to clear the market, said the first sellside source. “If the market is receptive, then they’ll come; if not, they’ll hold back. Morrisons will be the deal that sets the tone for the year.” 

The supermarket is waiting on (hopefully) bumper Christmas numbers to issue, buysiders report.

More broadly, the buyside sees plenty of drivers for hot issuance next year: Private equity dry powder remains ample, and, with countries across Europe dipping in and out of restrictions, there is more pent up demand left in reopening sectors. 

With expectations of plenty of supply, buysiders are split between caution and confidence, with some preferring to focus on clipping the coupon on stable assets and others keen to root around for reopening risk assets.

Nonetheless, corporate auctions which will need M&A financing have been slow in December, the sellside said. “The M&A horizon is pretty clear at the moment, it’s just the usual ebb and flow,” said the second sellside source. M&A processes started in late Q3 and Q4, however, are still ticking along for Q1 closings, with financings to launch soon after. 

Discussions to refi 2024 and 2025 maturities are also underway, buysiders and sellsiders flag. Overall refi and repricing levels, at the mercy of credit spread technicals, remain harder to predict, although both buyside and sellside think a repeat of early 2021’s repricing rash is unlikely.

“Some of the distressed refinancings - I don’t think those will repeat,” said the second buysider, naming Kloeckner Pentaplast, as well as Boparan and Standard Profil in HY. These firms are unlikely to refi again so soon after 2021’s outings, but the poor performance of the deals may mean other stressed borrowers struggle. The Kloeckner €600m E+475 bps TLB in question is trading at 97.25 pts as of 17 December 2021 from a 99.5 OID, with its SUNs trading at 92 pts. Similarly, Standard Profil’s SSNs are down to 82 pts.

UoP: Recap around the Christmas tree

Fewer recaps came to market in 2021 than buysiders expected. Just 8% of 2021 loans included recapitalisation as the use of proceeds, versus 13% in 2020 (weighted, of course, towards the pre-pandemic period). In their stead, refinancings and LBOs dominated H2 2021 after a repricing rash in H1, encouraged by slim margins, fell away as pricing crept up. 

Buyside and sellside both expect 2021 to make up for this recap paucity. “Recaps, and increasing sponsor-friendliness more generally, is our number one market-specific concern going into 2022,” said a fifth buysider.

Overall, 33% of euro loans issued in H2 included LBO as a use of proceeds, while 31% included refinancing. At the other end, just 3% and 5% mentioned repricing and recaps respectively. FY numbers push LBOs down to 22% and bring repricings up to 15%.

Margins: Step(down) into Christmas

Margin ratchets were central to buysider’s 2021 complaints – both the increasing aggressiveness in new deals, and the ease with which some credits hit their leverage-based stepdowns. 

At least 35 loans (30% of total) pushed through three margin stepdowns in 2021 versus 49 that cut down to two.* Around 63% had the first stepdown at 0.25x deleveraging from opening. The majority – around 55 deals – had a six-month ratchet holiday; three snuck through with no holiday at all. Where an ESG ratchet was included, the majority of deals (13%) settled at a +/-10 bps ratchet.

Two sellside sources were surprised at ratchets taking up buysider brainspace. “The push on ratchets, between two and three stepdowns and so on, is like a dance,” said the third sellside source. “It’s routine.”

Some buysiders brought up inflated marketed EBITDA numbers as contributing to their stepdown stress. Sellside sources agreed, with one mentioning scrapping a pre-marketed deal after buysiders expressed they couldn’t accept the marketed EBITDA. “They didn’t think they could understand EBITDA going forward or what the real value of that number was,” said the second sellside source.

But most buysiders instead said 2021’s ratchet focus stemmed from how quickly many credits blasted through their stepdowns. “I’ve been surprised multiple times when ratchets hit, but not from EBITDA inflation, from outperformance,” said the fourth buysider. “Sometimes it’s companies leaping frogging the first stepdown and going straight to two stepdowns, sometimes it’s coming a quarter earlier than I expected.”

Buysiders named 2021’s outperforming sectors – Building Materials, Healthcare, Consumer Services, Tech – as particularly rife with this issue.

However, this is unlikely to repeat in 2022, buysiders report, with these names already at their lowest ratchet and sponsors likely to relever outperforming companies through recaps. Buysiders also do not expect a repeat of 2021’s strong performance in these sectors, meaning any new ratchets won’t clock in so easily. 

“As much as I’m dismayed about weak docs, I do want to reset margins, and if that’s through recaps, so be it,” said the fourth buysider. “In the beginning of 2021, B2s were printing at around 350 bps – now, a B2 is 375 or 400 bps, and that’s probably going to be the case early next year too. Ratcheted deals can be as low as 275 bps, so I’m eager to take them out.”

New issue single B euro loans ended 2021 on an average of E+394 bps after January lows of E+375 bps and November highs of E+408 bps, according to 9fin data.

This margin pressure isn’t enough for all buysiders, however. A sixth said: “Too many recaps are a risk, if too many companies who don’t know what they are doing come and pile on debt, they might not be able to sustain the leverage. A lot of companies we expect to come with recaps are ones that overperformed in 2021 and will decline going forward.”

On broader complaints of sponsor-friendliness, sellside sources deny that covenant deterioration accelerated in 2021: “It’s continued on the same trajectory. Perhaps investors hoped that the pandemic would improve protections, but docs continued like the pandemic didn’t even happen,” said the second sellside source.

The third sellside source said: “Buysiders are successful in pushing back on the normal stuff like three ratchets and no ticking fees. It’s a bit of a performance. You put in 10 things they don’t like and you know you’ll get five through.” They added: “Ticking fees were a common battlefield this year.”

Where a ticking fee holiday was granted, around 14.9% of docs set it at 60 days, according to 9fin numbers, followed by 45 days at 10.5% of deals.

Inflation: Let it grow, let it grow, let it grow

For seven buysiders, 2022’s main plotpoint is inflation. How rising costs will impact credits has become a fundamental question at the credit committee, both buyside and sellside say. Less attention is paid to market technicals, meanwhile, where most predict just modest spread widening if rates exceed the 0% floor (again, read more in our CLO outlook here). 

“Loans have almost set prices, they aren’t as volatile as high yield,” said the first sellside source. “You won’t see 6% on a B2 loan, so price movements are moderate.”

“This is my main headache,” said a seventh buysider. “It’s the margin effect from the time lag in passing costs onto customers and consumer ability to meet those prices. I was generally bullish on this previously because consumer savings are still elevated and wage increases are ahead of inflation. Now, I think there will be a bigger squeeze on consumers than expected and companies will really have to focus on cutting costs.”

Rising costs have especially hit retail, consumer goods and grocery names, with buysiders picking out Asda and Iceland as prime examples. Increasingly, buysiders see EBITDA declining on retail names despite revenue increases in the face of these cost headwinds, resulting in a sell off of these supermarket names in the second half of the year – though this was also motivated by supply overhang from the upcoming Morrisons blockbuster.

Raw material costs, in particular, have been a headwind across sectors. In bonds, Reno De Medici added back material costs increases on its €445m E+525 bps 2026 FRNs in a move investors pegged as “cheeky”. Buysiders expect both bond and loan issuers to follow suit in 2022.

Naturally, buysiders are split on how severe and persistent inflation is likely to be in Europe, as well as how quickly central banks will respond to it. Optimists see inflation coming down to a soft landing in Q2, while pessimists see it stretching through to the end of the year. 

Broad buysiders expectations are that Euribor will swing positive in H2 2022, though expectations for central bank action more broadly have been muddled by the Bank of England’s rate hike last week. “That was a shock in the market,” said an eighth buysider, “it was really unexpected and the market is digesting that.” 

Still, with a rising rate backdrop, loans, as floating rate instruments, are poised for a stronger 2022 than bonds. This carries on from 2021, where loan issuance was 11% up on HY after lagging 22% behind in 2020.

“H1 2021 was interesting for the resurgence of loans,” said the second sellside source. “Bonds were favoured by borrowers in the first half, but loans were more resilient in the second, and I expect that to remain the case for the start of 2022.”

Sectors: I just want you for my loan

Breaking down by sector, Materials more broadly accounted for 16.4% of 2021 euro loan issuance, per 9fin data, second only to Healthcare at 19.4%. Other hard hitters were Consumer Discretionary (15.5%), Communication Services (12.0%) and Industrials (11.0%). Runts include Energy (0.3%), Real Estate (0.5%) and Utilities (2.9%).

Several buysiders plan to be underweight in the sectors which dominated 2021, such as Healthcare, Tech and Consumer Discretionary. Some eyes, instead, are on opening reopening trades (Travel and Leisure), with others backing names that could recover from supply chain blows (Automotive, Chemicals). 

“There’s lots of scope for earnings improvement in chemicals,” said the ninth buysider. “For our chemicals names, pricing was strong in 2021 but volumes were still down as demand was handicapped by supply chains.” 

Elsewhere, automotive names, albeit sparse in loan land, could recover from 2021’s major chokehold of semiconductor shortages, three buysiders speculate.

Another worry is how this year’s outperformers (Healthcare, Building Materials) will manage pullback from a strong year in 2021, though most buysiders are “cautiously positive” on many names maintaining flat revenues into the next year. “Flat is fine from a credit perspective,” said a 10th buysider.

Leisure remains contentious. The sixth buysider argued its largest cost (labour) is the hardest area to cut costs, and worried about the sector’s capacity to delever. However, two Leisure analysts stayed bullish on 2022’s prospects, pointing to Moody’s recent upgrade of several holiday parks from CCC to B3 (including PortAventure and Parques Reunidos).

The fifth buysider described Leisure as a “neutral trade”: “If footfall goes away, prices go up; once traffic returns, prices normalise. Many leisure names, like Merlin Entertainments, outperformed our expectations this way. Volumes will come back post-Covid in a massive way and pricing will normalise.”

Supply Chain: 12 delays of Christmas 

Another central question in 2022 credit committees will be ongoing supply chain disruption. As with inflation, investor concerns centre on companies’ ability to pass costs on. Eventually this will hit demand, buysiders argue, and companies will have to give back any 2021 margin expansion they might have enjoyed.

Opinions on severity vary by sector. Analysts covering Healthcare, Buildings Materials and Consumer Services were sanguine. “Sure, it will continue to weigh but there are no credits that I particularly worry about on this aspect alone,” said the sixth buysider. Over in Chemicals, supply chains normalising is one of biggest pockets of opportunity in 2022 as risk assets rally, a ninth buysider said. 

Concerns are keenest in Leisure and Retail, though Packaging analysts also remained worried. “I’ve been going over companies with international supply chains, especially those reliant on Asia,” said the seventh buysider. “Even now, there’s serious delivery delays on goods at the moment, and that’s worrying, especially for seasonal sellers if you miss your window.”

COVID: Stay another day

Buyside largely dismissed concerns about newcomer variant Omicron and Covid-19 more generally, with an 11th buysider describing the market as “fatigued” with it. “No one worries about this anymore,” they said. Although all acknowledge the fundamental uncertainty, none expected another major, protracted lockdown.

Few expected Omicron to have a material impact on credit conditions. “We have a playbook on how to deal with this, we know the supply chain issues, we know the lockdowns, we know which companies will be hit,” said the fourth buysider. “This won’t be the only variant set-back: this is the new normal.”

The second sellside source said: “There is a similar tone on Omicron as on Covid over summer. People think they've done enough work on impacted names over the past 12 months that they can take a view on where those names should price and are happy with that.”

Still, some buysiders spent much of December pouring over their portfolios for Covid-related weaknesses. Some differ in how to approach UK vs EU companies. “The UK and Europe are out of sync now. Which will be more important in the end: the UK’s bigger Omicron wave vs the UK’s quicker booster rollout?” asked a 12th buysider. 

Again, this remained a worse worry for Retail and Leisure analysts. “If every winter has a new variant wave, there’s consumer caution, there’s possibly restrictions, and then that will be an issue,” said the seventh buysider, naming cruise operator Hurtigruten’s winter Antarctica cruises as an example.

“With Covid in the background, those other issues that have been overshadowed can come to the forefront,” said the fourth buysider. “2022 will be a very interesting year.”

Happy Xmas (Wrap is Over)

*We have based our data on final documentation / terms where these have been made available to us. For deals where we have not received final documentation / terms, our data is based on preliminary terms.