Over the last 18 months, we’ve seen a marked shift in the leveraged finance landscape. With senior debt pricing now well below its recent peak, banks are aggressively stepping back into the market with a strong lending appetite, competing actively both to retain existing clients and to win new relationships. For investors, this is not simply a refinancing story, it has direct implications for equity returns, capital structures and competitiveness in the M&A market.
Banks are competing harder than ever for new mandates. Refinancings and new to bank acquisition facilities are being aggressively targeted, with lenders willing to sharpen both pricing and structure to win new to bank deals and defend deals they already bank. The result is downward pressure on margins, more flexible terms and faster execution, particularly for strong cash generative assets backed by reputable sponsors.
For sponsors, cheaper senior debt improves the economics of leverage and allows them to offer structures which can support a higher EBITDA multiple. Lower senior debt interest costs means cheaper equity coupons, although the risk for differential pricing remains, the equity price becomes cheaper. This potentially enhances free cash flow, increases resilience and, in principle, supports higher equity returns. It also creates scope to rebalance capital stacks, whether by increasing senior leverage at a cheaper price, reducing reliance on more expensive subordinated debt instruments, or refinancing legacy facilities put in place during less favourable market conditions.
Importantly, cheaper debt is also unlocking greater capacity for portfolio companies to invest in capex and also bolt on acquisitions. With lower financing costs, businesses can accelerate growth initiatives that may previously have been deferred, from entering new markets and expanding production to investing in technology or fast tracking strategic projects. For sponsors, this increases the opportunity to drive balance sheet growth and strengthen value creation plans.
However, these favourable conditions are not just beneficial to private equity houses. Trade buyers are also benefiting from improved financing markets. Traditionally more conservative on leverage, many strategic acquirers are now prepared to borrow at lower cost, making them increasingly competitive in auction processes. The M&A market is becoming more crowded resulting in rising valuations, and sponsors face a risk of return squeeze if they are not disciplined on entry pricing.
A clear illustration of the influence of senior debt pricing on private equity structures can be seen in loan note pricing. Although loan note yields have not yet decresed, this is an emerging area of focus in the current market. As the market settles to the new world of more stable, lower senior debt margins, it is possible that, as new funds are raised, loan note yields may begin to trend downward once again.
How we can help you
As market conditions shift, you’ll be best positioned to unlock the opportunities created by cheaper debt if you proactively assess your financing options.
Our Banking & Finance team advise private equity clients and sponsor backed companies on refinancings, new acquisition facilities and wider capital structure planning. We would welcome a conversation about how these dynamics could support your investment strategy.
