Corporate Financing Analysis - 2018 To See Leveraged Loan Market Momentum Continue - 15 JAN 2018

The 2017 popularity of the US leveraged loan market is set to endure in 2018 thanks to the strengthening macroeconomic backdrop and the growth emphasis for corporates provided by recent tax reforms. BMI believes that such favourable conditions will outweigh the slowly souring fundamentals for the leveraged loan market which, were it not for the ongoing boom in economic growth, would leave the investors who have taken on high levels of risk through such facilities highly exposed. But that is not the case.

Continuing To Build Steam
US Leveraged Loan Issuance By Deal Value, USDmn
Source: Bloomberg, BMI

With interest rates sat at record lows and with demand for high-yielding assets high, the US leveraged loan market enjoyed a record run last year and subsequently reached a new high for the combined value of facilities issued. In such a competitive marketplace, and with such facilities proving to be hugely popular with investors looking for returns, leveraged loan issuers were able to increase the level of risk wrapped up in deals, forcing investors to make concessions with the quality of what they were buying. As a result, leveraged loan portfolios are pumped full of risk thanks to an increase in convenient-light loan deals - we highlight that so-called 'cov-lite' means the loosening of terms on deals. According to Thomson Reuters LPC data, such cov-lite lending tallied as much as USD25bn in the US in 2017, which represents a more than three-fold increase on the USD7.49bn haul of cov-lite deals secured on the eve of the global financial crisis in 2007. Were it not for the strengthening macroeconomic backdrop and the continuation of 'animal spirits' among yield-hungry investors catalysed by it, we would be concerned by such numbers and by the high level of downside risk in loan portfolios more broadly at present. But with growth strengthening, such fundamentals will unlikely serve as too much of a drag on ongoing leveraged loan issuance in 2018 and will, instead, likely have lenders continuing to offer cov-lite terms on deals going forward. In sum, all the while the going is good, the leveraged loan market will continue to flourish.

2017: The Record Year

Thanks to increasing demand for the financing of takeover deals, BMI highlights that the uptick in lending activity last year saw US leveraged loans record their third consecutive increase in combined deal value and their second annual increase in deal volume. According to Bloomberg data correct to December 20 2017, total loans issued across the course of the year tallied USD1,931,766mn, an increase from the previous record high of USD1,707,783mn set during the 2016 full-year period. Deal volume, meanwhile, totalled 4,135 in the US last year, up marginally from 4,119 in 2016 and 4,027 a year earlier in 2015. The total number of deals, however, remains below the record 4,745 issued during the 2012 full-year period, meaning that the average leveraged loan deal has grown in size on the back of growing investor hunger ( see ' US Leveraged Loan Market To Continue Record Run ' , July 19 2017). We note that the largest leveraged financing of 2017 came in the form of office supplies retailer Staples' USD2.9bn term loan backing of Sycamore Partners' buyout of the Staples delivery business with a consortium of banks, including UBS, Bank of America Merrill Lynch, Deutsche Bank, Credit Suisse, Royal Bank of Canada, Jefferies, Wells Fargo Bank, and Fifth Third Bank providing financing for the deal (see ' PE Buyouts To Continue Disappointing In H217 ' , July 25 2017). Not all leveraged loan deals were secured for acquisitive growth purposes, however. Instead, we highlight that a growing number of facilities have been sourced to refinance existing loans and to push out debt maturities and all with lower borrowing costs, thanks to the long-running climate of low interest rates, which is set to soon come to an end.

2018: Plenty Of Potential

2017 may have been a record year for the market, but thanks to a strengthening US growth outlook and the passing of recent tax reform, 2018 may be even better, BMI notes.

Improving economic growth in the US is good for potential activity levels in the US leveraged loan market as it gives investors the confidence to keep taking on risk while giving issuers the impetus to keep issuing deals with favourable terms. In the view of BMI's Global Team, US real GDP growth will come in above-trend and above-consensus in 2018 and 2019, led by a surge in private investment. Several factors have led us to re vise our forecasts, including: the surprising resilience of the US economy in H217 , the passage of tax reform earlier than we expected, and key leading indicators increasingly pointing upwards. As a result, we have raised our forecasts for US real GDP growth in 2018 to 2.6%, up from 2.1% previously, and in 2019 to 2.2%, up from 2.0%. In doing so, we have gone from being below consensus to above it by 0.1pp in each year.

Focusing in on the passage of the Tax Cuts and Jobs Act (TCJA) on December 22 2017, BMI believes that this package of reforms will serve to make 2018 an active year for several corners of the corporate financing arena, with the leveraged loan market among them. This is primarily because the bill included significant reductions in corporate tax rates which stand to be implemented by the end of Q118. While BMI believes that the net economic impact of the Act looks as though it will be modest overall, some provisions in the TCJA will help boost growth immediately, with the most notable being a corporate tax rate cut to 21% from 35%. This cut, together with the proposed relaxation of regulations on US leveraged loans, will keep acquirers on a spending charge, and the leveraged loan market busy over the coming months.