Leveraged Loan Market Faces Turbulence Amid economic Uncertainty

The leveraged loan market is experiencing increased volatility as economic uncertainty, notably concerning trade and potential recession, prompts investors to re-evaluate thier positions. This shift is causing companies to reconsider tapping into the riskiest segments of the loan market, impacting both European and U.S. deals.

Deals Pulled as Investor Sentiment Shifts

Several companies have recently withdrawn or postponed leveraged loan plans. As an example, UK production company All3Media and French insurance broker April Group shelved plans to reprice existing leveraged loans in Europe. Similarly, crop-protection company rovensa pulled a planned €1.1 billion ($1.2 billion) loan refinancing and extension.

The Dynamics of Supply and Demand

Previously, “robust inflows into credit funds — combined with a lack of new loans — had led to a feeding frenzy in M&A-starved leveraged loan markets.” This surroundings allowed companies to reduce pricing on existing debt due to intense competition among investors. Now, however, “the volatility is allowing investors to push back on private equity-owned borrowers — and demand extra compensation to finance deals.”

Rising Margins Reflect Increased Risk

The average margin for new issue leveraged loans has increased, reflecting the higher perceived risk. Last week, the average margin was 323 basis points over the benchmark, compared to 287 basis points in late January. This widening spread indicates that investors are demanding greater returns to compensate for the added uncertainty.

Secondary Market Sees Pricing Drop

According to Morningstar’s European Leveraged Loan Index, European leveraged loans experienced the largest one-day drop in secondary pricing since October 2023. In the U.S., prices in the secondary market have fallen to levels last seen in August. Among the U.S. offerings pulled from syndication was a leveraged loan sale for Pursuit Aerospace.

Expert Insights on Market Conviction

“As of the uncertainty, it can be hard to have conviction to sell a business and get the value you hoped,” said Rob Fullerton, global head of leveraged finance at Jefferies. His comment highlights the difficulty companies face in achieving desired valuations amid market instability.

Not All Gloom: Acquisition Deals Still Present

Despite the overall market unease,some deals are still progressing.Approximately a third of recent launches involved acquisitions. Apollo Global Management Inc.-owned packaging company Novolex Holdings LLC initiated an almost $3 billion financing to support its purchase of rival Pactiv Evergreen Inc. Avalara,a Vista Equity Partners-owned tax-software company,is set to save as much as $90 million in annual interest by refinancing $2.5 billion of private debt via the leveraged loan market.

Broader Credit Market Trends

Pricing has widened on recent deals from SolarWinds, TripAdvisor, and Alltech, signaling a broader trend. Analysts at firms including Barclays Plc and Goldman Sachs Group Inc. have raised their forecasts for spreads on U.S. credit. Notably, Barclays analysts indicated their forecast reflects a roughly 20% risk of recession, compared to the less than 5% risk priced in by spreads.

Leveraged Loans Trading Above Par Decline

JPMorgan analysts report that the percentage of U.S. leveraged loans trading above par is at a 13-month low, standing at 10.7%, a notable drop from 33.8% on March 1. This decline underscores the shift in market sentiment and investor confidence.

Impact on Primary Issuance

The drop in prices is impacting primary issuance. On a recent Monday, typically a busy day for launches, only two new U.S. leveraged loans came to market as investors focused on acquiring bargains in the secondary market.

Navigating the Volatile Leveraged Loan Market

Given the current volatility and economic uncertainty, it’s crucial for investors and companies to exercise caution and conduct thorough due diligence. Assessing the potential impact of trade tensions and economic slowdowns is essential for making informed decisions. Investors should carefully evaluate risk-adjusted returns and consider diversifying their portfolios to mitigate potential losses. Companies seeking financing should explore alternative funding sources and stress-test their financial models against various economic scenarios. By adopting a prudent and proactive approach, stakeholders can navigate the turbulent waters of the leveraged loan market and position themselves for long-term success.

The leveraged loan market is currently grappling with significant headwinds. As economic uncertainty persists, it’s vital for investors and companies to stay informed and adaptable. Are you prepared to navigate these changes? Contact a financial advisor today to discuss your investment strategy.