(Bloomberg) — Sales of U.S. leveraged loans are likely to stay strong for at least the next few months thanks to private equity buyout activity that is showing few signs of abating.
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There are deals already in the pipeline, including Hellman & Friedman and Bain Capital’s leveraged buyout of Athenahealth Inc. That transaction is expected to include $10 billion of debt, at least some of which will probably be loans.
And there are deals that haven’t yet been announced, but are already in the works. Private equity firms with funds focused on the U.S. have about $960 billion of money to invest, according to research firm Preqin, and many are looking to put together deals before interest rates rise much further.
“They’re deploying their capital into transactions and that’s what’s driving volumes,” said John McAuley, co-head of debt capital markets for North America at Citigroup Inc. “There is a lot of money that’s been raised that needs to get invested.”
The deluge won’t last forever. Federal Reserve officials expect to raise rates three times this year and again next year, according to median forecasts. As rates rise, floating-rate debt including leveraged loans gets more expensive, and fewer buyouts will work financially.
As a result, many Wall Street banks are forecasting a slight dip in leveraged loan issuance in 2022 compared with last year’s record figure. Barclays Plc is expecting as much as $500 billion, down about a fifth from last year, excluding repricings, according to data compiled by Bloomberg.
Buyouts helped fuel record U.S. leveraged loan sales of more than $600 billion in 2021, the highest since at least 2013. In 2021, private equity firms accounted for a record 24% of the more than $5 trillion of acquisitions globally, according to data compiled by Bloomberg, as cheap money made it easy to load companies’ balance sheets with debt.
A key deal was the $34 billion buyout of a majority stake in Medline Industries Inc. by private equity firms Blackstone Inc., Carlyle Group Inc. and Hellman & Friedman. The transaction, announced in June, was the biggest since the global financial crisis, and relied in part on about $7.73 billion of leveraged loans denominated in both euros and U.S. dollars for financing.
“It gave people a lot more confidence in the ability to look for other situations like that because the deal performed exceptionally well,” Grant Moyer, head of leveraged capital markets at Mitsubishi UFJ Securities USA, said during a press event in December, referring to the Medline deal. “There are transactions where you could see $30, $40, $50 billion.”
Some key leveraged loan sales to watch for in 2022 include the Athenahealth deal, a buyout expected to close at the end of March. About another $2.5 billion of leveraged loans in both dollars and euros will likely come to finance Brookfield Business Partners LP’s acquisition of Scientific Games Corp.’s global lottery services and technology business, according to people with knowledge of the matter.
Leveraged loans gained so much in 2021, rising 5.2%, that it might be hard for them to perform as well this year. Banks’ estimates for total returns range from 1.8% to 4.5%, and many money managers see those returns coming mainly from interest rather than price gains.
As for leverage multiples, there is not a “huge amount of room to run,” especially in heavy cash flow sectors like tech or health care, according to Sandeep Desai, co-head of U.S. leverage finance at Deutsche Bank. “You’re already seeing deals getting done somewhere between 7 and 7.5x in terms of leverage,” he said at a press event in December. Deals with more leverage than that typically end up getting done in private markets.
Equity checks are also higher, according to Alexandra Barth, who also serves as co-head of U.S. leverage finance at Deutsche Bank. “It’s going to be, I think, challenging for private equity to really increase leverage substantially from where we’ve been,” she said.
Shift to SOFR
A potential hiccup to the market next year may come from the transition to the Secured Overnight Financing Rate, or other benchmarks, after new offerings tied to the London interbank offered rate ceased last week.
About $16 billion of leveraged loans sold last year were tied to SOFR, including Authentic Brands’ $2.2 billion deal to fund its acquisition of Reebok, according to data compiled by Bloomberg. That’s a small percentage of overall volume and several structures are being tested, so much of the potential volatility from the transition is yet to be seen.
The shift shouldn’t damp investor appetite for debt tied to the benchmark, though. Demand is still expected to be strong as money managers turn to leveraged loans to hedge against inflation, given its floating-rate nature. Looming rate hikes could benefit the asset class as well.
“We are confident there will be continued strong demand for floating-rate investments including bank loans” if there are three Fed rate hikes in 2022, said Frank Ossino, bank loan sector head at Newfleet Asset Management.
Elsewhere in credit markets:
Blue-chip corporations are forecast to sell $125 billion to $145 billion of bonds this month, according to Bank of America strategists.
U.S. leveraged finance markets could see junk bond sales of about $30 billion and leveraged loan issuance in the area of $50 billion in January, according to median estimates in an informal survey of five Wall Street dealers and researchers
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But the slump in developers’ shares wasn’t matched by bonds. Chinese high-yield dollar bonds rose as much as 1 cent on the dollar on Monday, according to credit traders
Separately, Golden Wheel Tiandi says in an exchange filing it’s received support from holders of about 80% of three dollar notes the Chinese developer is looking to swap, a move that would allow the company to push out maturity payments
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