Slumping Leveraged Loans Are Expected to Rebound Late in 2023

M&A activity should come back in the second half, and so should this favorite borrowing instrument, according to JPM and Morgan Stanley.

 


Risk aversion hampered the mergers and acquisitions trade throughout 2022, and so a key financing tool for buyouts has waned, too. But leveraged loan volume should bounce back in this year’s second half as M&A finds its mojo again, two prominent Wall Street firms project.

Leveraged loans—bank borrowings involving highly indebted companies, most often for buyouts—had been growing in popularity in recent years. In 2021, a banner year for U.S. acquisitions’ issuance of lev loans, as they’re known, hit a record $600 billion, up threefold over a decade, Leveraged Commentary & Data stats show.

But last year, amid spiraling interest rates and fear of an oncoming recession, M&A deals dried up, and hence lev loans did, too, shrinking in volume to $200 billion.

“It has become much harder for sponsors to raise the same quantum of leverage and find the lenders to provide it,” wrote Stefanie Birkmann, a partner at M&A-oriented law firm Ropes & Gray, in a late-2022 research paper.

Barring a deep recession—many on Wall Street now expect a mild downturn or a modest economic growth drop that doesn’t qualify as a recession—the thinking today is that M&A will pick up. With much of the fear gone that inflation is out of control and interest rates will skyrocket, acquirers are anticipated to be emboldened as 2023 wears on.

What’s more, private equity firms, the vanguard of M&A activity, are sitting on a large amount of cash: $788 billion, per PitchBook research. Many are under pressure from their limited partners to deploy this dry powder.

That’s why J.P. Morgan analysts believe that leveraged loans will reach $300 billion in the year’s second half. In the same spirit, Morgan Stanley reports puts the figure at $275 billion. The loans carry maturities ranging from five to seven years, and only a small amount of them come due in 2023, worth some $10 billion. That means fewer loans will need to be rolled over at rates possibly higher than current levels.

Thanks in part to their more flexible, floating-rate structure—an advantage as interest rates rise—these loans are increasingly the go-to debt instrument for U.S. corporate speculative debt issuers. Their rates are reset every one to three months.

For investors, the allure of lev loans is that they pay more interest than other debt securities: an average 10% annual yield to maturity, compared with 9% for junk bonds and 5.4% for investment-grade paper, according to Eaton Vance, a Morgan Stanley unit.

On top of that, they are liquid, as most are packaged into pools, called collateralized loan obligations, or CLOs. Finally, they are higher up the capital structure than bonds, so investors do better with them in bankruptcy.

Related Stories:

Why Leveraged Loans Are Closing In on Junk Bonds

 

How CLOs, Despite Seeming Risky, Got to Be So Popular

 

Leveraged Loan Boom Is a Threat, Says BofA Chief

Tags: , , , , , , , ,

«