CJ Doherty: Welcome to the lending lowdown. I'm CJ Doherty, Director of analysis at LSEG LPC and today I'm delighted to say we're going across the Atlantic to hear about the current trends in the European leveraged finance market. And so it's great to be joined by Ben Thompson, head of EMEA leveraged finance capital markets at JP Morgan. Ben, thanks for joining me.
Ben Thompson : CJ. Thanks for having us on. Appreciate it.
CJ Doherty: Great. And so before we dive into the q&a on market conditions, can you give us a little bit of background about your role at JPMorgan and also housed? After starting your career in the US, you ended up in London?
Ben Thompson: Sure, absolutely. I'll be brief. So we can talk about more interesting content. But my role, my role here is I'm the, as you mentioned, head of EMEA leveraged finance capital markets, for JP Morgan in, in Europe, based in London. So anything that we get involved with relating to underwriting and distributing high yield bonds or leveraged loans, we'll run through the team that I've run. And we'll also get involved as well when some of the underwriting on investment grade loans, both for NBF, but also for for the MENA region. I've been here 12 and a half years before that I was with firm for almost 20 years in the US largely in the leveraged finance capital markets team. So that is me.
CJ Doherty: Okay, great. So thanks for that background information. Now, let's discuss conditions in the European high yield bond and leveraged loan markets. And I guess to start off, like, how are both markets faring now that this summer holiday season is over?
Ben Thompson: Great question. Things, we've come back in very robust health in both products. For substantially similar reasons. I think we had a very quiet issuance month in August. And that's always a trigger for cash balances to start building. I think surprising, though, to the upside, as we've come out of the summer, there's been a wave of clo formation on the loan side, which is the primary buyer base for leveraged loans in Europe. Obviously a big component of the US market as well, but but probably even more so here in Europe. And we've been pleasantly surprised that since mid July through through now, we've seen 16 vehicles price in the European clo market, which has brought a total of roughly 6 billion euros of new firepower in the leveraged loan market. And on top of that, there's another likely 4 billion that's trying to price in September and October across the market. So that is has brought a very liquid and feel to the leveraged loan market and as a result very constructive behaviour from from the leveraged loan buyers here on the high yield side similar dynamic but slightly different in that issuance has been anaemic as it has been on the leveraged loan side. But in contrast to Clos as a source of new money into the high yield market. Most of the money that's coming into that market has been from separately managed accounts and coupon clipping because the high yield market in Europe generates about 1.5 billion euros per month on average of coupons which go back into the hands of the investment managers who then look to redeploy that is a new issue. So that's the positive technical side on the on the demand side on the supply side, as we expected and I think had been well signalled. There's not much of a new issuance calendar of net new money expected in the back half of this year, Europe. So as a result, while we've seen a pretty nice pickup in activity, particularly in the last two weeks, it is remains a very much refinancing driven market. And as a result, while the market is as active now as it has been since any point pretty summer, it is active with refinancing trades. And there's a little bit of new money getting brought to the market. But for the for the most part, what's going through market right now remains refinancing trades and should stay that way through the back half of the year, we've only got eyes on about 2 billion of m&a related volume that is to come between now and the end of the year. Obviously, that could increase but that's where we are for now. And to contrast that number was 40,000,000,002 years ago. So we've we've really don't have much to come and upset this technical balance that we've gotten the market right now.
CJ Doherty : Okay. And in terms of just going on to the staying with the m&a side that you mentioned, you know, you know, prior to the financing part, like you know, just focusing on kind of m&a discussions. Do you know are more discussions taking place these days, you know, what are you seeing and hearing? Is there any, any sign of an uptick there?
Ben Thompson: Yeah, to stay on, on an optimistic tone there absolutely is and we split the it take it with a bit of a grain of salt because we've had a couple of periods like this during the course of 2023 where there was an uptick in m&a dialogue, and a number of potential transactions that count increasing sharply. But then what we've seen a couple of times before this year is those auction processes have unravelled for one reason or the other, either the buyer and seller couldn't agree on price and the transactions got got postponed, or in a couple of cases, one point before summer. Unfortunately, while the m&a process did complete, the the actual financing went into the direct lending market. I say, unfortunately, from the point of view of the distributed market, which buys leveraged loans and high yield bonds. So it's been you know, they've been a couple of false dawns so far this year, it feels like we're in a good position. Right now though, we're we're back again from summer and starting to see and feel that same kind of increase in the amount of potential dialogue around transactions starting to pick up but this time, I think the the X Factor, we hope will be those incredibly robust conditions for issuance and for borrowing in the leverage markets that you're on right now, we certainly hope will serve as a catalyst to get a number of these transactions finally over the finish line. So fingers crossed, and with a with an optimistic tone, we'd like to think we'll see a number of transactions get signed up in q4. And if they don't get issued in q4 to the market that will build a calendar for 2024. So cautiously optimistic that we are starting to see a slightly improved down there.
CJ Doherty: Okay. And just to take a step back for a moment, in the prior question, you mentioned that there was like a lot of refinancing getting done as opposed to like the new money m&a deals. For those deals, like is there any common characteristics there in terms of the quality of the deal or anything, which kind of, you know, defines those deals?
Ben Thompson: There, there is a certain commonality to them, I'd say, for the most part, what we're seeing is a lot of activity, particularly in the last couple of weeks on the loan side. So what we have seen a few bond for bond refi is there's one in market right now. For example, across Sterling and euros, most of the volume has been in loan format, and most of it has been in a min to extend format as well. And we're really seeing that across all kinds of credit ratings and industries. So everything from double B's down to weak, single B's, have been able to get through the market. He's clearly seeing a differentiation and differentiated outcomes across those executions. And you're getting obviously, much tighter pricing done on the better rated transactions, the larger, more liquid deals. But right now, the market seems to be open pretty much across the board for every sector and every ratings grade. Clearly, if you're trying to get something done that is you call it weak, weak single B rated. In a tough, tougher cyclical sector, you're going to have a bigger battle on your hands to get to a conclusion. But as long as the company is viable with the extended capital structure and the cash flows makes sense, even the weaker rated credits, I will get a hearing right now.
CJ Doherty: Okay, and you briefly touched on pricing there. So broadly speaking, what are you seeing in terms of, you know, movement on pricing and other terms and conditions?
Ben Thompson: Yeah, so on pricing, again, it's hard to characterise because you can have a huge range of outcomes. But so I'll probably stay away from throwing numbers at you. But if you looked as I pre summer to where we are now, on an apples for apples basis, you're probably seeing spreads tightened in by about 50 basis points from where they were pre summer, and your NOID is probably 50 to 100 basis points tighter. So a meaningful move and again, driven by at least temporarily that very strong technical where you've got large cash balances and not enough to issue supply to to use up the cash. So I think it's I wouldn't call I wouldn't call it a voluntary, voluntary moving pricing, it's probably a little more involuntary. But that's that's the scale of the move that we've seen. And clearly, you'll see probably less of that at the more extreme end of the credit space. And then and, and or, conversely, the better end of the credit spectrum because in Europe, at least on the loan side, you struggle to go too tight because you are so reliant on the on the CLO buyers and those those vehicles are subject arbitrage and have trouble going super tight. But in the middle call the the middle of the bell curve there and single b b pu B flat type ratings. You know that's where I think you're seeing things come in probably 50 basis points on margin and the 50 to 100 on Friday, so meaningful both and we are seeing things in that band clearer much close. sort of par that we've seen at any time this year. And we're seeing that also reflected in secondaries where we're now up to almost 10% of the European loan market trading above par, which is an extraordinary level considering at the start of the year, that number was, was fair. Fair enough. Zero.
CJ Doherty: Yeah. Great. Excellent, some good colour there. And just a pivot now for a little bit. How would you describe the relationship between the syndicated loan market and the direct lending market in Europe? You know, competitive complimentary, does it vary based on individual credit?
Ben Thompson: Yeah, so it's a great question. And what we've seen over the course of the past 24 months is a is a waxing and waning at any given point of both of those products. You know, we certainly saw last year when a very difficult year for the distributed market in 2022, we saw a great window for direct lending and a lot of success on the direct lending side, when a number of the underwriters who typically drive our market were struggling and in many cases offline and not willing to underwrite new transactions, or if they were willing to do transactions to do so with really substantial caps, which in some cases made potential transactions look very challenging from the point of view of financing. So that was a great window for direct lending. And a lot of direct lending deals got printed, I think that the balance is definitely shifted now back in favour of the distributed markets, then sort of pause for a second there, because that doesn't mean direct lending is not viable anymore. I just think if you look at the economics of where some of the recent transactions have gotten done, and take an extreme view of the world pay, you're alone getting done at E plus 325. With 50 basis points a discount, that's going to be extremely hard to match in the direct lending market. We have seen direct lending pricing, tightening in and sympathy with the improvements in the distributed market. But there's still a pretty broad gap right now between where you will price a direct lending deal, and where you could get where you could get a print in the distributed market. We saw that first. Earlier in the year, we started to see recovery. More on the high yield side, which for a period was was more liquid. And where you're through the caps on most of the underwritten high yield deals, you were probably inside where you were the levels you would achieve on a direct lending deal. We're certainly now in that position as well on the distributed loan side. Now, as I said, as a caveat, that doesn't mean direct lending is not viable. And we're not going to see direct lending deals. We certainly seen one process that we were involved in earlier in the summer, a transaction that got to the finish line with a fully underwritten loan solution that ultimately did go to the direct lending market. So there are other drivers beyond pure price that will push the borrowers to decide to go to the direct lending market. In some cases, it's an unwillingness to go to the rating agencies and unwillingness to provide the level and depth of reporting required to issue high yield. So there are a number of factors that can still push a borrower to go to the direct lending market. But certainly, if you were a execution in execution mode today, there's no doubt in my mind that you get much more competitive pricing terms in the distributed market than the direct lending market. So those two products will continue asked about the relationship between the two of them. Sort of like it's like a binary star system, the two orbit each other. And at any given time, depending on which one is more advantaged, you could get better outcomes in one or the other. But there tends to be trade offs. And that goes a lot with what's going on in the macro economic backdrop.
CJ Doherty: Okay, great. And now I want to talk about credit quality, you know, given that we've seen rates rise, you know, sharply in the last year, how is credit quality looking and both the leveraged loan and high yield bond markets? Are you seeing any signs of deterioration? Yeah,
Ben Thompson: I'd say it's modest. I mean, outside of some particularly, you know, idiosyncratic names where you have companies that have had a business model that's failed, or that were extremely highly leveraged and were subjected to some sort of particular disruption from things like inflation or raw material input costs. For the most part, we're really not seeing as much stress as we might have thought and part of that is down to the fact that you know, if you have financed yourself in a floating rate market, whether that's through fr NS or loans, there's been the gradual increase in interest rates. So, your capital structure has already absorbed a fair amount of the pain of rising rates. And then in the case of the more high yield fixed rate, finance companies, those have for the most part chosen not to come back to market and take the pain of what will be substantial moves in their in their interest expense, when they go from call it mid 4% cost of financing to mid seven to 8% cost of financing. All in one fell swoop. That stuff only going to cause, I think some challenges for some of the high yield issuers. But for the most part, we've seen an incredible ability of companies to pass through inflation, which was one of the main concerns as a driver of potential credit deterioration. So for the most part, companies have been extremely successful in doing that. And now, in fact, is we're starting to see some deflationary pressure on things like raw materials, a lot of these companies have been able to hold price. So profitability has actually been very good. We do expect and this is, you know, in the words of our publishing analysts, we do expect that we will see a modest uptick in defaults. But certainly no one's expecting those numbers to get extreme. And we're talking a low, low single digit numbers through the course of 2024, which really shouldn't be a major setback to the market, there still will be some of these idiosyncratic credits that struggle, whether they've waited too long to refinance and miss the refinancing window or are having some particular challenges I mentioned because of of a particular raw material situation, or an input problem. Those are the kinds of credits that I will see a few things struggle and have to get restructured. But it does feel at this point, like it's going to be a very manageable scenario through 2024.
CJ Doherty: Okay, and before we finish up, Ben, it's always good to look ahead. And so what's your outlook for the rest of 2023? And into 2024? What should we be keeping an eye on?
Ben Thompson: Yeah, I think look, there's still there's still a fair amount of work to do on maturity walls in 24, and 25. So you've got a total of just over 140 billion that still needs to get resolved, and 24 and 25 and extended. To give you a sense of scale, when you included 23. In those figures from the start of this year, that total versus the one 40 billion I just mentioned, was 200 billion. So we've chipped away at 60 billion of that. There's also a pretty, pretty good 100 billion plus figure that has to get resolved in 2026. And we're already starting to see people address those maturities, particularly the early 26 maturities. So that is, if you take the view that we have that the market is open and conducive, and even for some of the more challenging credits, we'll want to find solutions to extend tenors, whether or not that involves some modest de leveraging, or some sort of more material concessions to lenders and investors. We do think that that is a very manageable amount of debt to refinance over the course of the next 24 months. But so one thing to watch as a result of that will be continued high levels of refinancing activity, we do think that the technical that I mentioned at the outset will hold the cash balances will remain strong, because we just do not have the visibility on net new money, which is going to you're going to be generated by m&a. So we do expect that the technical wall. So calling for a pretty heavy refinancing calendar, excuse me, as discussed, should start to see we hope a pickup in m&a activity sort of like financing conditions are very conducive to a pickup an m&a activity. But I think that's going to be a more first half of 24 story then then end of 23 story. So those are kind of the big themes. And then in the background, we're going to watch for potential disruptors on any of the potential macro issues that we've been following for the last two or two years. Higher interest rates, persistent inflation, the conflict in Ukraine, and how that affects energy prices. So there are still any number of potential disruptors out there that we have to keep an eye on, the market seems to be comfortable with those for the most part right now. But clearly, to the extent that we got a change in direction in an unexpected way, on any of those macro drivers, you could start to see a pickup in defaults, more concern spreads widening, in a more challenging environment. But for now, it's hard to it's hard to make that call if anything, it feels like we're in a very constructive, fairly predictable and fairly benign environment for people who are trying to raise money in the leveraged loan and high yield markets in Europe.
CJ Doherty: And with that we will wrap up for today. We will certainly keep a watchful eye on the European bond and loan markets as we start to look ahead to 2024. And thanks for joining me, Ben and sharing your insights. It's been great. Hopefully we'll talk again in future. Super thank you for joining and thank you all for tuning in. I invite you to check out our European syndicated loan news and analysis at loan connector.com also follow us on Twitter at LPC loans. I'm CJ Doherty. Subscribe to the Lending Lowdown on your favourite podcast platform.
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