Overview
European leveraged finance markets stormed 2023. The Morningstar European Leveraged Loan Index (ELLI) recorded an annual ex-currency return of 13.4 per cent (the highest level since the Global Financial Crisis) while the ICE BofA Euro High Yield Index showed a return of 12 per cent for the same period.
At this point, I’m obliged to say that past performance is not indicative of future results. Indeed, this week’s Chart Room illustrates just how much the picture can change from year to year. And the financial backdrop in 2024 is likely to be very different to 2023, with central banks expected to hold or reverse the rate hiking regime that has characterised the years following the pandemic. So, what should we expect?
If rates settle at their current levels, returns on floating-rate leveraged loans would remain strong, and terms on high-yield bonds - which have become increasingly correlated with their private debt counterparts - would be likely to keep pace.
Even if central banks do pivot in 2024, a fall in the base rate should not mean that leveraged finance returns fall into negative territory (as they did in 2022). Indeed, we believe that a normalisation in the rates environment could encourage more buyout activity from private equity firms, with more leveraged buyout (LBO) financing deals brought to markets.
Over the past year, European LBO volumes have plummeted, with only €8.2bn of buyout-backing leveraged loans completed in 2023, down from around €22bn in 2022 - and the lowest figure recorded in the market since 2009. In the high-yield sector, only €2.8bn of issuance was used to back buyouts in 2023, the lowest figure since 2012[1].
Instead, supply across the primary markets in 2023 was dominated by refinancings and deals to push out the maturities on existing debt. This is likely to continue in 2024 with plenty of borrowers still looking to replace facilities or bonds maturing across 2026 and 2027. But this may come in in addition a marked up-tick in LBO deals fuelled by pent-up demand from private equity firms eager to get their buyout cycle moving again - not least because sponsors are facing pressure to exit investments they have stayed in for longer than planned.
When there is a significant pick up in the volume of LBOs - likely in the second half of the year - the new financing transactions to fund the deals will not only introduce new names to the market (a move that would be relished by collateralised loan obligation, or CLO, buyers that rely on diversity) but may also carry the sort of new-issue premium that could boost returns for investors.
Whatever happens with rates, we cannot expect the same record-breaking returns in 2024 that 2023 delivered. But this year should bring other benefits - more buyout activity, more new paper, more diversity - that could boost the market besides just decent yields.
[1] Source: Pitchbook Leveraged Commentary & Data, January 2024
