Private equity shops in Europe took advantage of accommodating credit conditions throughout much of 2018 to rack up levels of debt not seen since the financial crisis.
The average debt/EBITDA multiple on all leveraged loans in Europe backing PE activity hit 5.7x in 2018, according to LCD. That's up from 5.3x in 2017 and is the highest such figure since 6.1x in 2007, at the peak of the exuberant, pre-crisis markets.
Average leverage across the first-lien tranches of those loans rose to 5x, topping the previous record of 4.9x from 2017, making it the highest level since LCD began tracking this data in 2001.
Meanwhile, the proportion of private equity-backed transactions in Europe levered at more than 5x increased in 2018 to a whopping 74% of the market by deal count, matching the share of highly levered deals in 2007. And some 37% of European loans backing private equity shops in 2018 were levered at 6x or more. While this is far behind the 51% seen in 2007, it is significantly larger than the 15% average recorded during 2008 through 2017.
Conversely, there was a drop in the amount of conservative deals.
Only 9% of sponsored loans in 2018 were levered at less than 4x, which is the smallest proportion since LCD started tracking this figure in 1997 (the average during the 21-year period since is 28%). The share of these lightly levered deals has been in near-steady decline since the peak of 57% recorded in 2009, the first full year after the financial crisis. In 2007 - at the peak of the pre-crisis boom - deals with leverage multiples of less than 4x made up 13% of issuance.
The general rise in leverage is echoed in the increasing popularity of financing structures that include junior debt products, with the proportion of deals financed through senior and second-lien debt increasing to 18% in 2018. That is the highest proportion since 2007, and almost twice the share seen in 2017.
While market participants say there remains plenty of investor appetite for leverage for relatively better-quality borrowers going into 2019, some expect investors to be choosier about leveraged credits on offer.
"We've already seen some pushback from investors on the very highest-levered deals," one private equity player said. "With the regulatory requirements of the banks [through the ECB's leverage lending guidelines] in focus, too, we could see a real step-back on multiples."
Others agree that leverage in the European sponsored financing space may have peaked.
"I think we may have seen the top of the market, from a leverage point of view," said one market participant. "While transactions will continue to be aggressively structured, leverage may not continue to rise from here. We've already stepped back from the top of the market in terms of pricing."
Average yields available on institutional term loans for private equity-backed concerns over 2018 remained low, but the market faced some volatility, especially in the second half.
Moreover, with little new issuance of loans seen late in the year, the market is awaiting more deal flow to get a better gauge as to where pricing should be. Some on the sell side expect European leveraged loan spreads, on average, to be roughly London interbank offered rate plus 400 basis points, which would push yields closer to 4.5%.
The rising leverage seen across all European sponsor-backed transactions in 2018 was echoed by the availability of increasingly bullish multiples on sponsor-backed buyout financings.
Average total leverage on European LBOs reached 5.5x — again the highest figure seen since the crisis — though first-lien leverage fell to 4.7x, from 4.9x in 2017. Importantly though, equity contributions to buyouts remained high, averaging about 48.1% in 2018 — the fifth-largest annual reading in the last 22 years — up from 44.5% in 2017.
Meanwhile, the average purchase price multiple on European LBOs in 2018 rose to 10.9x — the highest figure on record. And 43% of buyouts had a purchase price multiple of 12x or higher in 2018, approximately double the average seen in the preceding four years.
Buyout- and M&A-related activity dominated sponsor-backed issuance in both the bond and loan markets during 2018. Across the leveraged loan market there was a greater volume of sponsor-backed buyout financings in 2018 than during any other year in the last decade, with €38.12 billion of such supply. Other sponsor-driven M&A activity accounted for €18.16 billion of loan activity, which is the most since LCD began keeping this data in 2000.
In the European high-yield bond market, meanwhile, the volume of sponsor buyouts again rose to the highest level on record, €9.71 billion.
But while sponsor activity in the European high-yield market has remained relatively strong in recent years, the leveraged loan market is the financing sector that is most relied upon by private equity firms.
And even when the high-yield market is used, there is an increasing preference from sponsors to use floating-rate notes, as issuers look to maintain as much flexibility as they can, while tapping into the loan bid in regions where loans themselves are too cumbersome to issue.
More to come?
As this year's market gets going, it is doubtful whether the record levels of buyout activity seen in 2018 will be matched in 2019. At the outset of 2018, participants already had visibility on jumbo buyouts, including KKR's acquisition of Flora Food Group, while news of Blackstone's takeover of Refinitiv emerged in January. In contrast, this year the pipeline of upcoming deals is thinner, with only the jumbo financing backing the takeover of Johnson Controls' power solutions business by Brookfield Business Partners sparking much excitement.
However, sponsors note that the financing markets remain broadly supportive, giving them confidence to continue looking at jumbo acquisitions, with more potential carve-outs already being considered.
"The pipeline feels really thin at the moment, but things can emerge quickly," said a senior private equity practitioner. "There's still increasing pressure on corporates to streamline and to spin off noncore assets — and those could move the needle very quickly. However, we may still struggle to match the volume of buyouts seen last year."
With volatility in the equity markets likely to see sponsor firms seek secondary buyouts rather than IPOs for their assets — or even look to take advantage of waning valuations with public-to-private transactions — participants are hopeful that yet more LBOs will emerge later in the year.
"I think if you look at the fundamentals, the amount of dry powder that sponsors are sitting on is incredibly high," said another market participant. "I'm very hopeful that the large transactions will come, even though we have less visibility on the jumbo situations than we did at this time last year."