What’s coming for the leveraged loan market | Troutman pepper

[co-author: Justin Wood]*

In a volatile market, systemic risks call for caution.

This article originally appeared in the May/June 2020 issue of Middle Market Growth, the official publication of the Association for Corporate Growth (ACG), which includes a bi-monthly print magazine, website and weekly e-newsletter. It is reproduced here with permission. Visit the official site here: http://middlemarketgrowth.org/.

As the coronavirus pandemic upends the economy, the financial health of the leveraged loan market has been affected. The long-term effect of the pandemic on the leveraged loan market will depend on inherent market risks, the extent of the pandemic, and government response to the crisis.

State of the Leveraged Loan Market

At the end of last year, total leveraged loans outstanding were estimated at just under $2 trillion, including $1.3 trillion held by institutional investors, according to testimony at an SEC committee hearing last September. The average leveraged trade has a total leverage of 5.5 times EBITDA, which is more disciplined than before the 2007-2008 financial crisis. In the middle market, banks continue to face increased competition from non-bank lenders who do not face the same regulatory pressures. This competitive environment, particularly in the area of ​​sponsored leveraged buyouts, has forced banks to make price accommodations and commit to maintaining market share. Looser covenants, including lighter lending and less stringent underwriting standards due to increased competition and the migration of sponsored deal terms from large-cap markets to the mid-market, had resulted in increased market risk . Additionally, EBITDA continues to be defined extensively through the use of EBITDA add-ons, leading to the possibility of leverage being higher than reported.

Impact of the coronavirus pandemic

In the short term, the pandemic has increased the use of revolver facilities for cash-strapped businesses or, when a business has no immediate use for funds, to make over-cautious withdrawals. Lenders authorized the drawdown of $215 billion between March 5, 2020 and April 9, 2020, as reported by S&P’s Leveraged Commentary & Data service. During this period, companies also postponed or changed cash payments to conserve cash.

The longer-term impact of the pandemic on the leveraged loan market is uncertain. It will be determined by the extent of the pandemic and the government’s response. Without outside help or meaningful long-term access to cash, companies are likely to default on their payment obligations and default on their financial commitments. Fitch Ratings revised its March 27 default forecast for US leveraged loans for 2020 to 5%-6%, from 3% previously forecast. This equates to $80 billion, surpassing the previous record high of $78 billion in 2009. Delinquencies are expected to be highest in the energy, non-food retail, restaurant and service sectors. travel and leisure.

Another concern is the ability of companies to refinance loan obligations at maturity. According to S&P’s LCD, March 2020 was the first month since December 2008 that the primary syndicated loan market had no new issuance. As reported by Refinitiv LPC, new money lending in deals supported by mid-market sponsors in the syndicated loan market during the first quarter of 2020 was $7.6 billion, down from 15% compared to the fourth quarter of 2019 and 13% year-on-year. The slowdown in new loans could be an indicator of refinancing opportunities. Some lenders have signaled their willingness to work with companies on waivers, payment deferrals and forbearances. Businesses should proactively contact their lenders when cash flow issues arise or in anticipation of refinancing.

*Troutman Sander

Priscilla C. Carnegie