The European leveraged finance market is in danger of overheating as booming demand and a lack of supply pushes issuance to levels not seen since the run-up to the financial crisis, according to a new report by Standard and Poor's.
There was €124 billion of new issuance of high-yield loans and bonds last year, the ratings agency said today – only just below the €133 billion of issuance in 2006.
“The return of the market for collateralised loan obligations, ample liquidity in the high-yield bond market, and investor appetite for higher yield are all fuelling leveraged finance activity,” said Standard & Poor's credit analyst Taron Wade.
This increase in demand has not been matched by a commensurate increase in supply, the agency said, since most of the relatively companies have already been recapitalised and M&A activity remains at below-trend levels.
The result of this supply / demand imbalance is that borrowers have been able to get increasingly attractive terms, including the return of covenant-lite structures. Leverage ratios have also been creeping up, S&P added.
The agency concluded that if this imbalance were to persist, especially in a low interest-rate environment, the likely result would be a further relaxation of lending standards and an increase in leverage levels – the sort of 'irrational exuberance' that was seen pre-crisis. This would ultimately have a damaging effect on credit quality, S&P said.
However, the agency also pointed out that there was no sign yet of any deterioration in credit quality in Europe. Dividend recaps actually fell in the first part of this year, thanks largely to the re-emergence of public markets as an attractive exit option for private equity, while leverage levels remain below the peak of 5.9x average debt to EBITDA that they reached before the crash.