Increasing volumes in the European leveraged loan market
Debt markets update
The new-issue volume of leveraged loans in Europe almost reached €80 billion in 2014, the highest level in seven years and an increase of 17% compared to 2013. Leveraged loans are loans provided to companies that, usually, already have considerable amounts of debt and they are generally associated with mergers and acquisitions as they provide the extra cash needed to facilitate a deal.
Leveraged loans tend to have higher interest rates than typical loans, reflecting the higher level of risk in issuing the loan. The volume of leveraged loans in 2014 was still significantly lower than the volume in 2007, a record year with a leveraged loan volume of €165 billion.
However, the upward trend in recent years, as shown in the bar chart below, is a positive sign that the European economy is recovering from the crisis and that companies are more willing to invest. A group of experts from the Loan Market Association (LMA), are positive with regards to the outlook for 2015 as they predict that the volume of leveraged loans in Europe will be somewhere between €80 billion and €100 billion this year.
Sources: S&P Capital IQ/LCD (2005 – 2014)
Forecast average LMA experts (2015)
One of the main drivers behind the increase in leveraged loans is the rise of M&A activity over the past few years. In 2015, this trend is expected to continue; in a survey with corporate executives and advisers, 82% said they believe their company or their clients will do a deal in 2015 (compared to 63% in 2014).
A second driver behind the increase in leveraged loan volume are cash-rich companies that are looking for interesting investment opportunities outside of the more common alternatives. With the current low interest rate it is interesting for companies with big cash reserves to lend their money to companies who want to expand through acquisition, as they will get a significantly higher return on their money compared to if they parked their cash in a bank, for example.
Another advantage of this investment strategy is that issuing levered loans is considered to be advantageous in times of rising interest rates, as we may see in the (near) future. Leverage loans tend to have floating interest rates (with a certain spread over a benchmark interest rate such as Libor or Euribor) which makes them a more interesting product for the issuer, as they don’t lose value in times of increasing interest rates, as fixed-interest-rate products do.
Of course there are still several insecurities to deal with in 2015, such as the Russian sanctions, the falling oil price and Eurozone instability, to name but three. But the increased volumes of leveraged loans in recent years and the positive outlook for 2015 are viewed by many as signs that the European economy is recovering and that we are headed for pre-crisis levels.
* Source: Bloomberg, European Corporate Bonds index, 5Y average maturity
(over 600 index members, yield = Yield To Worst)