Five takeaways from the AFME Leveraged Finance conference

No rest for the weary – after going through an unprecedented pandemic, we find ourselves in another type of turbulence: the volatility of the capital markets.

I recently had the opportunity to attend AFME’s 17th Annual Leveraged Finance Conference and here are my takeaways from the event:

Access to public capital markets will continue to be difficult in the near future.

In a volatile and difficult macroeconomic environment, investors are adopting a more defensive position. They are looking to reduce their exposure in terms of duration, some are limiting their exposure to the UK and looking to higher quality credits. There is a real concern about how and which companies will weather the current economic challenges. Rating agencies are concerned about interest rate hedging (the ratio of a company’s earnings to its interest rate obligations), the ability of companies to pass on rising costs to customers and companies’ ability to cope with rising inflation.

Growing apprehension about borrower flexibility within existing financing documentation.

Over the past decade, defaults have been very low (less than 1%) while liquidity has remained very high. In this environment, alliances have become increasingly permissive. However, investors are now more concerned about how much value borrowers can erode (due to covenants) and how much that would limit the rally in a downside scenario. They also fear being subordinated to other creditors, either because the borrower may take on super senior debt or because the borrower may withdraw assets from the credit ring and link those assets with new debt.

Private credit has provided an interim solution, but it cannot substitute for public capital markets in the long run.

Capital users have tapped into alternative sources of finance, including private credit during these difficult times. From the borrower’s perspective, the main advantage of private credit has been a simpler process than public syndication. However, private credit agreements generally contain more restrictive clauses than syndicated agreements and, above all, the pot of money is too small. A borrower who approaches existing lenders to augment their existing financing may be informed that there is no more capital available.

An increase in liability management transactions, restructurings and distress-related M&A transactions is likely.

Borrowers who cannot refinance their existing debt with new money can use various liability management operations to extend maturities. Various European countries have also adopted a restructuring directive which could help clean up the balance sheets of certain zombie companies. Finally, as companies go through tough economic times, we could see a wave of distress-related mergers and consolidations.

ESG financing needs to be scrutinized more closely by investors.

ESG funding scrutiny will increase when markets return. Investors will want ESG goals to be more ambitious than the borrower would in the normal course. Investors will also focus on third-party verification and reporting against ESG objectives. Finally, the financial penalty for non-compliance with ESG objectives must be significant enough to dissuade borrowers from neglecting the ESG objectives defined at the start of the financing.