March 10, 2023 - On March 8th, the LSTA and LMA jointly hosted their annual London conference. Addressing the packed conference room, Tess Virmani of the LSTA and Gemma Lawrence Pardew of the LMA welcomed the conference delegates and provided an overview of the associations’ accomplishments and areas of collaboration during the past year. Then Trevor Williams, cofounder of EXGuard and Chair of IEA Shadow Monetary Policy Committee and Economic Consultant, set the scene for the day by highlighting the challenges of the global economy. The 2020s have had a rocky start with a global health crisis and a global energy, food, and price inflation crisis triggered by Russia’s invasion of Ukraine. These global shocks, added to climate change and other geopolitical issues like the rise of autocrats (even in the US), are placing great strain on international institutions and the rules-based order that has unlocked so much global prosperity in the last 75 years. Over the next few decades, migration will be the sole driver of population growth in high-income countries. With the world’s population now at 8 billion and expected to peak at 11 billion, Williams noted that the march of global prosperity continues, but if the world’s population all wanted to live as Americans do, it would require four earths to meet their demands.
Elizabeth Leckie of Allen & Overy then led the primary market panel with Michael Craig of Invesco, Lewis Grimm of Jones Day, Jeremy Selway of Deutsche Bank, Jane Summers of Latham and Watkins, and Kate Weinstein of Morgan Lewis. The past year for leveraged loans in Europe has been the worst since the global financial crisis. Fortunately, most of the underwritten deals have now cleared the market, pricing has recovered, inflation is abatng in Europe, and the CLO market is functioning. The default rate in Europe is less than 1% but is expected to tick up later in the year. The panel then shifted to a discussion of liability management transactions in the US noting the two types of transactions that have received a lot of attention: the JCrew style “drop-down” transactions and the “uptier” transactions. (As an aside members are reminded that the LSTA published a Market Advisory – Liability Management Transactions: Drafting Fixes in December 2021 to assist members as they navigate these transactions.)
David Chmiel, Managing Director of Global Torchlight then presented the day’s key note address, “Any Sign of Light on the Horizon: Geopolitics and The Loan Maret in 2023?” Chmiel started with a sobering quote by Admiral Sir Tony Radakin, RUSI, from December 2022: “War crimes. Sham referendums. Faux annexations. Arbitrary detentions. Show trials. Summary executions. Populations being bussed to ‘camps’ in another country. Millions put at risk of famine. Hundreds of millions suffering the pressure of increased energy prices, inflation, job losses, and the consequences that follow, whether mentally or physically. Nuclear threats. Nuclear anxiety. Crazy nuclear debates about whether ‘tactical nuclear weapons’ can be distinguished from ‘strategic nuclear weapons’…But it gets worse. Because the other challengers to the world order do not stand still.” One year ago there may have been a negotiated settlement between Russia and the Ukraine. Ukraine’s President Zelensky was prepared to do a deal with Putin; however, that is now off the table, and there is no desire to broker such a deal today. This is leading to a war of attrition – moving street by street and house by house. There is every indication that will become the norm, but wars are unpredictable. Still global opinion remains that people do not want their own militaries becoming involved in the conflict; they do not want this to become a NATO / Russia conflict, and thus prefer to equip the Ukraine to fight and keep the sanctions squeezing Russians. People fear a global conflict involving superpowers some time in the next quarter century. We may question whether big government is here to stay. Governments have become more interventionist in recent years because of the pandemic, increased financial services regulation, and broader international security concerns. When asked if one’s country was on the wrong or right track, other than China and India the trajectory is not good. In the US, there has been a huge collapse in trust in the government amongst Republican voters, and this could play into the national security situation. Everything can change quickly, however. We live in a fast moving ever-evolving world, and the circumstances governing our geopolitical world could be very different in three to six months .
Tess Virmani then led the next panel discussion on “Sustainable Finance: Maintaining Integrity” with panelists, Tom Freke of Bloomberg, Oleg Khomenko of A&O, Robert Lewis of Sidley, Laura Pendakis of KPMG, and Orith Ozoulay of Natixis. Sustainability linked loan issuance has enjoyed rapid growth over the past few years but like all debt SLL issuance has slowed in the past year as debt volumes generally have dropped. By industry, financials lead the way in SLL issuance. What has the the European loan market seen with SLL in the past year? ESG is so prevalent and present in European transactions. The lending landscape has changed and with the advent of private credit there is appetite from fund mangers to adjust and pivot towards ESG. The area is largely unregulated but there is regulatory pressure on the outside looking in and thus there is tension in the market as it adjusts. But whether the product has the integrity is the true factor. Notably, the Sustainability Linked Loan Principles were recently updated and tried to create a harmonised approach. From a practice perspective, these continue to be bespoke transactions with no one size fits all. The KPI that a borrower selects is all bespoke. This is an evolving market, and the integrity of the product is paramount. Both the LSTA and LMA are, therefore, committed to keep updating and refreshing the Principles to ensure that opportunities to greenwash are kept at bay.
The conference concluded with a discussion of defaults and recoveries led by David Gillmor of S&P Global with Matt Dunn of Clifford Chance, Chris Kandel of Morrison Foerster, Robert Schach of Reorg, Robert Reynolds of Pemberton Capital Advisors, and Nick Wood of Grant Thornton. Not surprisingly, European defaults are expected to rise moderately in 2023 to about 3.25% but that does not seem too bad when compared to previous cycles. With inflation higher than originally expected and rates, therefore, ticking up, interest coverage ratios are now a real concern. Although firms are gearing up their restructuring teams, no one is expecting this cycle to be too bad. Leverage has been at five times in recent years, firms have liquidity facilities in place, banks are in better health, and there are no covenants to trip up companies. There is a looming maturity wall and the ability of companies to refinance is what should be focused on, but both European and US markets face only a gentle hill in this regard. In 2021 many issuers took advantage and refinanced, and most leveraged finance borrowers should have no problem refinancing if they have no underlying issues. Over the past 20 years in Europe, the average recovery for first lien loans has been 72.5% and 78% in the US. This time round it is expected to be 10- 15% lower. Because of the lack of covenants the company may be at a much later stage when they come to the table this time round. The biggest impact on good or bad recoveries will be jurisdiction, leverage, and sponsor behavior. Whether a sponsor will let a company drift into default is critical. Sponsors can make disposals and use proceeds to retire debt; they can amend and extend; they can restructure and accelerate the restructuring — there are many ways a sponsor can be more active in the management of a company during a downturn. The behavior of sponsors in the past couple of years has been constructive and helpful, and they are expected to continue in this way. With respect to CLOs, the consensus was the CLOs should perform fine as they can absorb the defaults and the losses, but, of course, the idea is to not experience the defaults by managing the assets. Historically they have performed incredibly well as an asset class, and they should do the same now.
Click here for the conference slides.