Leveraged Loan Market 2021 – Year in Review

Yes, we absolutely have to do it before the end of the year” – Everyone

It was the common refrain at the end of last year of an overloaded market that was in desperate need of a vacation – including yours truly, which caused this “Year in Review”, like many transactions, to slip at the beginning of 2022.

But what a year it was. After the rollercoaster of 2020, we have seen a strong comeback of new financial transactions in 2021. KWM has been pleased to support our sponsor, corporate and lender clients on many landmark transactions including the acquisition of Icon Cancer Care by EQT, the acquisition of ProbeCX by KKR, 1300Smiles P2P by BGH/Abano Healthcare Group, the acquisition of Hazeldene Chickens by BGH, additional facilities for Icon Cancer Care and APM, IPO financings for Pepper Money and Latitude and the refinancing of Permira/I-MED.

Australian Term Loan B (TLB) market – who broke the dam? ![1]

We help our clients grow the Aussie TLB market during the last years since Apollo/Leighton Services’ Ventia deal in 2014. Adoption was initially limited, driven by concerns about the appetite of investors (who are used to seeing or need a maintenance financial commitment) , wider flexible layouts or density (no one likes a 2-page paragraph), and unfamiliar American-style documents.

2021 can be considered the year of the dam break! Our sponsor customers are increasingly looking for cov-lite TLBs as one of their top options. There is a lot to do up front in structuring deals, managing multiple lender trees, customizing US law and/or US market concepts for Australian borrowers/businesses and Australian law, documentation and syndication. However, sponsors realized the pain was worth it, with competitive pricing, the ability to push leverage, and general flexibility in terms.

More importantly, the depth of local liquidity and the range of potential investors surprised on the upside, with Australian issuers’ borrowing of AUD TLBs outpacing other currencies for the first-ever year and the standalone Australian TLB market governed by Australian law (i.e. not tied to a USD/European tranche nor to be traded in the US/European based investors) makes perfect sense.

KWM was co-advisor on EQT’s Australian TLB for its investment in Icon Cancer Care, setting the new benchmark as the largest AUD TLB ever and the first to cross the AU$1 billion mark. We also advised KKR on its Australian law, all AUD TLB to support its acquisition of ProbeCX. Other major Aussie TLB transactions during the year include KKR’s investment in CFS, MIRA’s acquisition of Bingo Industries, MIRA/Aware’s acquisition of Vocus, additional facilities for Icon Cancer Care under its pre-EQT ownership and expanded one-liter facilities for Madison Dearborn’s APM and KKR’s Arnotts. .

We strongly expect this trend to continue in 2022 and beyond, with the following key themes:

  • Historically, the lack of an active secondary market has been cited as one of the reasons for the capping of the size of the Australian market. Instead, the market expansion last year appears to have been driven largely by increased appetite from buy-and-hold funds. We continue to watch with interest whether there will be a corresponding increase in secondary debt trading volume and frequency.
  • Rating requirements previously acted as a barrier to entry into the TLB market for some borrowers (from a cost or hassle perspective, or both), pushing them into other products. It is now clear that unrated Australian TLBs are possible, which should stimulate demand.
  • It will be interesting to see how the “battle of forms” develops. Global sponsors have generally insisted that their “latest and best” material should come from the United States or Europe. For the first Australian TLBs, the arrangers were in favor of using an offshore precedent, because the universe of lenders they marketed were accustomed to and more accepting of this approach (and, in the event of difficulty in syndication, a switch to offshore was possible). As the local market has matured, we’ve seen some arrangers resist, as they now primarily cater to local financiers who find US-style documentation and concepts difficult to pass on compared to the local market. ‘APLMA/ LMA style documentation used in this part of the world. Local sponsors and borrowers are also looking for a more digestible starting point. The next logical step is for this market to develop a new “Australian-style” TLB precedent.

Unitranche is here to stay

Unitranches continued to prove their worth in certain segments of the market. In particular, we are seeing sponsors attracted by the relative speed and ease of executing a unitranche with a single lender or club – without the need for a rating (although things are changing on the AUD front TLB) or the risk of a draw-off TLB syndication period (and the risk of being inflexed at the end of it). Others are reassured by the “known quantity” and relationship to chosen unitranche lenders, compared to a potentially unknown and broad syndicate.

In larger capitalization deals, unitranche lenders lost market share to TLBs, given the cov-lite nature of TLBs and the relatively cheaper weighted average cost of a 1L/2L TLB. The European and American unitranche markets have adapted by relaxing the conditions and potentially removing the covenants (the “cov-lite unitranche”).

Many unitranche lenders take the “if you can’t beat them, join themapproach and be open to participating in 1L/2L should this be the sponsor’s ultimate choice of debt product.

Traditional bank debt – quo vadis?

While this evolution of TLBs and unitranches appears to have taken market share away from traditional bank debt in larger-cap deals, bank debt continues to play an important role in small-to-mid-cap deals. In large-cap deals, the inherent advantages of traditional bank debt remain compelling for the right deal, including:

  • tighter prices
  • major acquisition lines / committed capex – which may be difficult to sell to TLB investors
  • ability to provide essential services such as hedging, bank guarantees, working capital facilities and other transactional banking lines

Faced with competition from TLBs and unitranches, bank lenders have also responded by:

  • stretch lever
  • offer more flexible accordions
  • remove or reduce depreciation requirements
  • switching to a unique leverage clause for the bargain.

COVID long

Like everyone else, leveraged loan markets were not fully immune to the continued impact of COVID in 2021 – especially for borrowers in exposed sectors such as retail, hospitality , travel and leisure. However, unlike in 2020, most well-informed borrowers were prepared and consent application processes did not have the same sense of urgency.

The most difficult (and in many cases unanswered) question remains whether borrowers can adjust EBITDA to account for the impact of COVID-19 (the so-called EBITDA before Coronavirus or BAIDAC adjustment). In 2020, the duration of the pandemic and its impacts remained unclear. Almost 2 years later, some might argue that COVID-19 is now the new normal, while for others the fact that the world is still grappling with this once-in-a-century pandemic that continues to reject new variants only underscores the “extraordinary” nature of it. As new loans are taken out or refinanced, we have seen some borrowers (or lenders) expressly document how and when an EBITDAC adjustment be done and what it covers, others expressly preparing standardizations for COVID-19 “bumps or bumps” and also as many people continue with the pre-COVID-19 wording on extraordinary adjustments.

LIBOR transition – the box has finally come to the end of the road

The year started with a strong reminder from the UK FCA that GBP LIBOR would cease to be available from 31 December 2021, prompting market participants to act to kick off their transition plan. After years of stagnation, the market reached a consensus quite quickly on most fundamentals of the documentation and GBP LIBOR was quietly adieu. There is still some work to be done on USD LIBOR ahead of the June 30, 2023 cessation date, but the way forward is much clearer and we see lenders getting a head start to (hopefully) avoid another crisis period.

Even LBOs go green

The long-term trend towards ESG/green/sustainable lending (SLL) has been underway for some time, with banks and borrowers building their ESG credentials by linking this to their pricing terms.

However, this was primarily the domain of corporate borrowers – and we had advised some of the pioneering deals in this space for Sydney Airport, Ramsay Health, Downer EDI, Estia Health and others.

We now see these characteristics in leveraged finance. In some deals, sponsors and lenders have included “agree-to-agree” mechanisms allowing them to set KPIs once the dust has settled. Others accept SLL terms from the outset, with common ESG goals being greenhouse gas emissions and other social goals, EQT’s recent refinancing of over NZ$1 billion of its village of retirement and its senior care business Metlifecare is one example. We expect this exciting trend to continue given the strong supply and demand pressure for more products.

Priscilla C. Carnegie