The European leveraged finance new-issue market ended the second quarter of 2021 with a bang, boosting the first-half volume totals to record levels. Total leveraged loan volume came in at €80.9 billion for the year through June 30, according to LCD — a tally already higher than full-year 2020 issuance of €64.9 billion, and the highest first-half issuance since 2007. For high-yield bonds, meanwhile, it was the joint-busiest quarter ever recorded in Europe, with volume of €38.3 billion (matching the first quarter of 2021), as well as the highest-ever first-half total, at €76.6 billion.
An incredibly active private equity market is driving this buoyant new issuance, with the volume of loans supporting buyouts running at the highest level since 2007. New buyouts are also driving much of the bond market activity, with 40.1% of new bond issuance sponsor-driven in the first half of 2021, compared to 27.8% across the whole of 2020.
Supply side economics
Meanwhile, new issuance tipped the loan supply/demand balance into a surplus for the second quarter, though this measure doesn’t take into account non-CLO demand, which is helping to keep the bid for leveraged loans strong in Europe. The market has absorbed the new supply with relative ease too, even though there was a clear widening in loan margins through the second quarter, as well as a little softness creeping into what had been a firm secondary market by late June as accounts churned portfolios to make room for further primary supply.
Institutional loan issuance totaled €33.7 billion in the second quarter of 2021, which is behind the first quarter’s robust €36.2 billion, but after that is still the busiest quarter the market has seen since the second quarter of 2007. This so-called “new money” influx has resulted in the biggest supply surplus in Europe on a rolling-three-month basis since April 2020. Investments into loans — as measured by European CLO issuance — have outstripped available supply for the last 9 out of 12 months, but with the surge of issuance in 2021 this dynamic could be shifting.
LCD calculates net loan supply by tracking new issues into the European Leveraged Loan Index (ELLI) minus repayments, which worked out at €11.1 billion for the second quarter. This compares to new CLO issuance of €6.9 billion for the quarter, leaving a supply surplus of €4.2 billion for the three months ending June 30. However, this calculation doesn’t take into account non-CLO funds in Europe, which also add to demand for the asset class, and investors have told LCD that they have seen more inflows into these funds in recent months.
In the first quarter of 2021, the supply shortage on LCD’s measure was €3.29 billion, and resulted in a compression in both loan spreads and yields for that period. Throughout the second quarter, overall pricing came off its lows to settle at E+375 for a good single-B flat borrower, up from around E+350 in March, with the best B-/B3 names also moving up by around 25 bps to E+400. In terms of averages, LCD data shows margins for single-B euro-denominated term loan Bs moved out from E+379.7 for the three months ending March to E+388.2 by the end of May, with yields moving from 3.92% to 4.06%.
Spreads compressed in June, moving from E+398.4 in May to E+397.8 at the end of the quarter on a rolling three-month basis for all single-B term loans. Yields backed up slightly to 4.20% from 4.17%, however, as original issue discounts (OIDs) got larger on average. On a quarter-over-quarter comparison, meanwhile, average primary new-issue pricing decreased (because of widening OIDs) to 99.4 at the end of the second quarter, from 99.7 at the end of the first quarter of the year.
Price tightenings (or reverse-flexes) on European loans still outweighed upward yield moves, with just two deals pricing wide of talk in the three months to June 2021, and 31 deals reverse-flexed. That said, reverse-flexes have been more palatable to investors recently as they have been focused more on tightening OIDs closer to par than on margin cuts, with the former impacting the yield less over the long term. This, however, makes churn tougher in secondary given a general lack of appetite to pick up tight-margin deals through par.
Direction of travel
Whether loan spreads will keep tightening heading toward the late summer will almost certainly be predicated on the direction of CLO liabilities. Managers note that loans have generally been a CLO-dominated affair in Europe this year, though there are signs of more inflows from multi-strategy accounts as inflation talk in the U.S. increases the attractiveness of the floating-rate asset class globally. Corporate default rates also remain low, and far lower than expected a year ago, with the measure running at 1.13% in Europe and 1.25% in the U.S., according to LCD (based on principal amount for the 12 months to the end of June).
According to LCD's first broad investor survey in Europe — which was conducted during the second quarter — some 70% of funds managed by respondents are invested in loans via CLOs, while 30% are invested via non-CLO funds (the respondents represented €39.6 billion of assets under management in Europe). Of those that reported the geographical split, 70% of CLO investors came from Europe, with the second-highest percentage coming from Asia (23%), and only 7% from the U.S. For non-CLO investors, 79% of their investors came from Europe, with the U.S. in second place at 15%, and only 6% coming from Asia.
Looking at other findings from the survey, half the accounts responding said they were seeing allocations to loans from their end-investors increase, while half said allocations were staying the same. Investors considered the biggest area of covenant erosion to be restricted payments (42% of respondents), followed by debt incurrence (33%), portability (17%) and asset sales (8%). LCD will be repeating this survey in the fourth quarter, alongside its annual default survey.