Deutsche Bank sees opportunities in the leveraged finance market

As borrowing rates have retreated from last summer’s highs, some life has returned to the leveraged finance market. The leveraged buyout (LBO) market itself remains quiet, however, so the emphasis has been on refinancing or extending existing deals. This has kept Deutsche Bank’s leveraged debt capital markets team busy for the past few months.

The leveraged finance market all but closed down after Russia invaded Ukraine in February 2022, and remained suspended as inflation shot up and central banks hiked aggressively.

The pre-invasion market had been very strong, points out Diarmuid Toomey, Deutsche Bank’s head of strategic capital markets, which includes leveraged finance capital markets, private debt, structured equities and equity-linked products.

“There was an extremely eager buyer base,” he recalls. “The market was powered by a collateralised loan obligation (CLO) machine and was very borrower-friendly. But the landscape changed over the past year.”

After February 2022, the CLO machine “began to sputter”, according to Mr Toomey. “It is now working again, but at a slower pace.”

The most notable change has been in the price of debt. “For a long period, sponsors could buy a company at an all-in cost of 3% to 4%,” observes Jeremy Selway, head of leveraged finance capital markets, Europe, the Middle East and Africa (EMEA) at Deutsche Bank. “They were able to pay high multiples because the cost of debt was low.”

Post-invasion, the all-in cost of debt rose to between 8% and 10%, but valuations did not change much, making the equity returns less attractive for buyouts. “For those previously interested in investing in the leveraged market, high-grade corporate debt could now deliver the same return, without the same level of risk,” notes Hoby Buvat, Deutsche Bank’s head of leveraged finance EMEA.

Market focus

After the summer, the mood began to lighten somewhat. The inflation outlook became less oppressive and investors needed to put their cash to work. By the start of 2023, the cost of finance in the leveraged market had come down a couple of percentage points.

Mr Selway points to Verisure, a Swiss-based security company and long-term issuer in the leveraged finance market, as a bellwether of changes in borrowing costs. Having raised debt in 2021 at 3.25%, Verisure was one of the first back into the market after summer 2022, paying 9.25% — same rating, same leverage. At the beginning of 2023, however, it was able to borrow at 7.125%.

Given the absence of new buyout deals, the market focused instead on refinancing existing ones. In the loan market, as Mr Toomey explains, borrowers who want to refinance have two options. “They can completely refinance, with a new deal, or they can go to the same lenders and amend and extend,” he says. “Those existing lenders will give you better terms than fresh financing.”

Deutsche Bank was joint global coordinator and bookrunner on a significant amend and extend exercise for Nord Anglia Education early this year, alongside HSBC and JPMorgan. Nord Anglia, a UK-headquartered international schools provider, is owned by private equity house BPEA EQT and Canadian pension fund CPP Investments. Deutsche Bank led its LBO in 2017, as well as subsequent add-ons.

Since then, the company has performed strongly. “It’s a great business, with lots of visibility on cash flows,” says Luca Laino, a Deutsche Bank managing director in leveraged finance capital markets.

With maturities coming up in 2024 and 2025, Nord Anglia was able to extend its existing €1.5bn first lien Term Loan B (TLB) facility to January 2028. It arranged a new first lien $610m TLB, also maturing in January 2028, repaying the existing $295m TLB. In addition, it made a $200m partial repayment of the existing $410m second lien and extended the remainder to September 2028.

Previously, the company’s entire US dollar debt was held by one investor. This exercise took out that investor, to be replaced by Nord Anglia’s debut syndicated US dollar TLB issuance. A revolving multicurrency credit facility was increased to $545m and its maturity extended by three years to August 2027. The spread to Euribor was 4.25% on the revolver and 4.75% on the euro TLB, while the US dollar tranche was priced at 4.5% over the secured overnight financing rate.

“We put in more first lien debt, which is less expensive for the borrower,” Mr Laino says. “The uplift on the euro TLB was only 150 basis points (bps), compared with 225bps or more on other recent amend and extend deals.”

Deutsche Bank introduced more than 70 new lenders to the syndicate, diversifying Nord Anglia’s investor base. The deal also achieved a one-notch Standard & Poor’s ratings upgrade to B (stable), despite the soft macroeconomic and elevated interest rate outlook.

Pro forma for the transaction, Nord Anglia’s first lien net leverage and total net leverage was 4.1 times and 4.5 times, respectively, based on 12-month earnings before interest, taxes, depreciation and amortisation (Ebitda) to November 2022.

High yield

Last year, Deutsche Bank was global coordinator and bookrunner, together with Barclays Capital, on the deal that reopened the post-summer euro high-yield market. This was a €350m issue of five-year non-call two senior secured notes for Lottomatica, Italy’s largest gaming operator.

Lottomatica was acquired by private equity house Apollo in 2021, since when it has been significantly increasing its online business. “The most interesting aspect of the deal was the unique structuring we put in place to address the non-typical use of proceeds,” Mr Laino says. “While the proceeds were raised to acquire a new company, for confidentiality reasons Lottomatica wasn’t able to identify the target at the time. So, we were raising a blind pool.”

Investors could take some comfort from an escrow mechanism, with a release condition set at 3.25 times pro forma net operating company (opco) leverage. If not used within 12 months, the funds would be returned to investors.

In a challenging market, pricing tightened to 9.75% at par from initial price talk around 10% yield area. The book was more than three times covered. Mr Laino says that, given the unusual circumstances, the bank’s reputation as a bookrunner which can be trusted contributed to the success of the deal.

Pro forma for the transaction, net opco senior secured leverage was 2.4 times, and total net leverage at holding company level was 3.3 times, based on 12-month Ebitda to June 2022.

In another post-summer deal, Deutsche Bank was lead dealer manager, along with JPMorgan, on a €1.385bn exchange of existing notes for German pharmaceutical company Stada. The transaction was notable for its size, as the largest high-yield corporate exchange offer since SoftBank Group’s 2018 exchange, also led by Deutsche Bank.

Stada wanted to lock in its existing noteholders, rather than participate in a new transaction. So, it offered to exchange their 3.5% notes due August 2024 into new 7.5% bonds due August 2026. The offer included an upfront cash consideration of €80 for each €1000 in principle.

The €1.385bn take-up represented an exchange ratio of 73% of the existing €1.885bn senior secured notes. “This was an innovative deal,” says Mr Toomey. “If you have a big debt stack with near-term maturity, you need to be creative because size can outweigh good quality.”
After the exchange, Deutsche Bank led a tender process for Stada notes due 2024 and 2025. This reduced the company’s near-term financing wall by another €272m.

Rate environment

The house view is that rates have higher to go, coming down again in the euro market only next year. But the leveraged finance market is looking good right now, according to Mr Selway. “Spreads are not very wide,” he says. “The credit market is not forecasting high default rates or a drop in corporate earnings, so it makes sense to do deals now.”

There may even be some more LBOs in the offing, with a need for finance. “Deal-making has been taking a back seat but, if there’s a strategic reason, companies and sponsors will go ahead with an acquisition, even if it’s at a higher cost of debt,” says Ms Buvat.

Mr Laino agrees. “We are still able to get deals done, even in the worst volatility,” he says.