Leveraged loan arrangers in the U.S. believe issuance is more likely to recede than advance in 2014. At least, if the forward calendar of all-important M&A loans is any indication.
The M&A calendar at the end of 2013 was relatively thin, with arrangers saying that screening activity remains lackluster. Apart from the middle market, which has been a relative bright spot lately, the landscape for large LBO deals – the loan market’s bread and butter over the last 25 years – remains challenging in the face of regulatory and market-based headwinds.
On the regulatory front, it’s no secret that government agencies are putting pressure on banks to hold the line on credit structures, as Bloomberg News recently reported. Sources say that regulators are exerting as much moral suasion and governmental pressure as possible on loans to issuers with debt ratios of 6x total or 4x senior.
Why is this important? Of the jumbo deals to emerge in 2006 and 2007 – those with loans of $1 billion or more – 57% by volume would be on the regulatory watch list.
Beyond the cool regulatory climate, the LBO market is facing even more significant structural challenges. For one thing, stock prices are at record highs, inflating the purchase price of all assets. For another, corporate profit margins are also at all-time highs as a result of years of cost-cutting efforts by corporate America (see figures 14 and 15 in this presentation from Yardini Research [PDF]). Finally, though U.S. economic growth picked up to 4.1% in the third quarter, few expect this accelerated pace to continue. Beth Ann Bovino, chief U.S. economist for S&P Ratings, projects GDP growth of 2.6% in 2014 and 3.1% in 2015.
This is not exactly a dream scenario for private equity deal-making, given high property prices, wide profit margins, and below-trend economic growth on the one hand, and with regulatory pressure to tamp down credit multiples on the other.
That’s not to say there will be no LBO flow in 2014. Arrangers think the drumbeat of screening continues, but the stars don’t seem aligned for an outburst in deal-making that might rival 2006/2007.
That will likely leave recaps and refinancings as the main drivers of loan production in 2014, as they were in 2013. But just how much horsepower these engines have left is unclear. After all, a scan of S&P/LSTA Index loans outstanding shows that 65% are to issuers that already have refinanced, repriced, or recapped (0h my.)
Unless the consensus expressed above proves wrong, and there is an unexpected pop in the number of jumbo M&A transactions financed with multibillion-dollar institutional loans, participants say loan volume is more likely to fall to $400-500 billion in 2014 than it is to match or exceed 2013’s record tally of $605 billion.
