Welcome to Debt Download, Goodwin's monthly newsletter covering what you need to know in the leveraged finance market. It's alive! With the debt markets—including buyout financings—coming back to life, borrowers had little to fear this month.
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In the News
- After a challenging summer, the broadly syndicated loan (BSL) market was more welcoming to borrowers in September, a trend that began before the rate cut and then picked up steam. Between the Labor Day holiday and the Fed's half-point rate cut, spreads tightened and covenants loosened, a turnaround from August. The market continued on that trajectory after the rate cut to close out the month with new issue volume net of associated repayments reaching $27.2 billion, well up from $13.1 billion in August. The average all-in spread of single-B loans fell sharply to S+377 (S+363/99.6 OID), from S+444 (S+409/99.0 OID) in August, which was a nine-month high. Flex also favored borrowers, with 27 loans tightened and two loosened for a 13.5:1 ratio, compared with 2.8:1 in August. The rate cut gave an immediate boost to the debt markets, with up to $25 billion in deals coming to market the week after, including 18 leveraged loans, according to Bloomberg Law.
- Dividend recapitalizations continued their record streak as private-equity sponsors sought returns on their investments in the absence of exit opportunities, though that too is starting to pick up (as discussed further below). Volume of dividend recapitalizations for PE-backed borrowers reached $69.3 billion for the year as of September 24th, putting this year in easy striking distance of the record of $76 billion, set in 2021. And while "such arrangements are raising eyebrows" as to the impact on borrowers' debt coverage, these transactions ultimately lead to "good outcomes" in giving PE sponsors flexibility in timing their exit opportunities. The BSL market also broke a monthly record for dividend recapitalizations, with $17.4 billion through September 24th, well ahead of the record of $13.4 billion set in July 2021.
- Through the first nine months of the year, the debt markets finally saw M&A and LBO activity recover from all-time lows in 2023, though partly at the expense of private credit deals. High-yield bonds and BSLs together reached $1.4 trillion in issuances, a 279% increase from last year. The gains came on the heels of a push by both public and private lenders to ramp up M&A-related loans. For example, sponsors are now being told lenders can provide "more than $15 billion of debt on a single junk-rated deal," a 50% increase from last year, according to Bloomberg Law. With the tone of the debt markets stronger—and with an economy increasingly conducive to deal-making—BSL arrangers are less anxious than before about this debt getting stuck on their balance sheet, or being saddled with hung debt. As a result, $2.4 trillion in M&A deals have been announced so far this year, up 22% from last year. Breaking this down by segment, BSLs picked up 68% of the $69.17 billion in LBO debt financing in the first half of the year, up from 46% of LBO financing during the comparable period last year. Direct lenders, meanwhile, saw their share of LBOs plummet from 70% in Q4 2023 to 28% and 36% of LBO deals in Q1 and Q2 2024, respectively. In fact, for only the second time since Q2 2022, the BSL market won more buyout volume than private credit (though private credit is still on top by deal count given the typical focus by direct lenders on smaller borrowers), demonstrating BSL's ability to compete amid lower demand. BSLs have also won back a significant share of debt from private lenders via refinancing this year, according to Bank of America and as reported by Bloomberg Law. Nearly $30 billion in debt across 70 deals moved from private to BSL lenders this year. The BSL market has won this business largely on the back of competitive pricing, which can be up to 30 basis points lower than that found on the private side.
- Private lenders also have sharp elbows and notched their own wins for the month. While BSL's surge began in Q1 2024, when public lenders looked to lower-rated borrowers (rated B-minus and lower), private credit regained ground against the BSL market by picking off lower-rated borrowers. The result was an overall increase in the credit quality of the Morningstar LSTA US Leveraged Loan Index. In order to hold the line, private credit has had to compete on price with the BSL market by squeezing its spread in PE-backed transactions to S+500-549 bps, from around S+600, according to LCD. And, of course, private lenders continue to maintain their advantage by offering deal certainty and flexible terms, including an increasing use of PIK options, according to an analysis by LCD, which notes that this trend is not necessarily indicative of stress on the part of borrowers, as PIK is also "optimal to fuel growth scenarios." Thus, even with BSL's recent head-to-head gains, private credit's explosive growth in new areas of lending, such as infrastructure projects and investment-grade and asset-based loans, continues, with Blackstone expecting the market to reach $30 trillion, up from its $25 trillion estimate only a few months ago (and well above the current $1.7 trillion).
- With both public and private sectors competing aggressively—and doing quite well—each side seems to be adopting the "if you can't beat them, join them" tactic. For example, at the end of September, Citigroup and Apollo Global Management launched a fund to arrange $25 billion in private loans, specifically targeting "corporate and financial sponsor transactions in North America." The fund will highlight the expertise of the private and public sectors, with Citigroup having the expertise to arrange and place debt and Apollo (particularly its Athene insurance division) having cash in need of deployment. This tie-up follows a similar—though smaller—alliance between Apollo and BNP Paribas.
- The default rate in the BSL market was 4.59% in September, which, as the highest since the financial crisis, is "raising red flags." This number may very well obscure the actual percentage of distressed borrowers given the recent trend in "silent defaults" that are resolved with lenders before an actual default under a loan agreement. In any event, much of the increase in defaults can be attributed to companies owned by private equity firms, according to an analysis by Moody's Ratings and as reported by Bloomberg Law. Moody's found that PE-backed companies defaulted at a 17% rate from January 2022 through August 2024, which is twice the rate found outside PE. Moody's concludes that these companies were more prone to filing because of PE's increased use of distressed exchanges and, as we noted above, taking on additional debt to fund dividends. Bankruptcy filings, however, ticked down for the month—to 59 from 63 in August, falling to the median for the year, according to S&P Global Ratings. Year to date, there have been 512 filings, led by the consumer discretionary sector, followed by industrials and then healthcare. This exceeds or approaches recent historical highs of 504 cases filed year to date in 2023 and 518 in 2020. Looking ahead, 42% of surveyed managers in the International Association of Credit Portfolio Managers believe defaults will rise in the near term, while only 20% say defaults will go down.
Goodwin Insights – Double Clicking on Innovation in Consumer Finance: Responsible Use of AI
For this edition of Debt Download, Goodwin partner Danielle Reyes and associate Nico Ramos take us on a tour of the increasing use of artificial intelligence in the financial services space, an area where change is coming fast and caution warranted in navigating the legal landscape surrounding the use of AI. Check out their updates and insights here.
In Case You Missed It – Check out these other recent Goodwin publications: California Finalizes the Department of Financial Protection and Innovation's Registration Regulations for Earned Wage Access Services Under the California Consumer Financial Protection Law; CFPB Takes the Next Step Towards Establishing Rules for Open Banking; FTC and DOJ Finalize Major Changes to HSR Form and Disclosure Requirements; CFPB Issues Guidance Emphasizing the Importance for Banks to Maintain Sufficient Proof of Customers' Affirmative Consent to Overdraft Services; CFPB Issues Advisory Opinion on FDCPA Compliance for Medical Debt; : A Look Ahead in Life Sciences: What We Are Tracking in the Fourth Quarter of 2024 and Beyond; Adjustment Escrows in M&A: Why the 1% Rule Doesn't Always Apply; OCC Approves Final Rule and Policy Statement on Bank Mergers; OCC Issues Bulletin on Refinance Risk in Commercial Lending
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