Subordinated debt use reaches highest level since 2014 – report

Subordinated debt is making a return in the leveraged buyout space as senior lending falls back, according to research by LCD, a unit of S&P Global Market Intelligence.

As M&A activity begins to pick up, larger deals are emerging and have led to increasing use of second-lien and high-yield bonds, LCD said.

The first quarter of 2018 saw deals exclusively using senior debt among European sponsored borrowers fall from a peak of 77.5 percent in 2016 to 58.5 percent, its lowest share since 2014.

Senior plus second-lien debt deals reached the highest percentage since 2007, accounting for 17 percent of all deals completed in Q1 2018. This is well ahead of recent trends which saw senior and second-lien deals account for an average of just 7 percent of deals from 2015 through to 2017.

LCD said second-lien debt is a little different in the post-financial crisis era, mostly in pre-placed form with direct lenders as opposed to being broadly syndicated. The amount of pre-placed second-lien debt in Europe reached €2.4 billion in 2017, up from €745 million the year before.

Second-lien leverage in Q1 2018 reached 0.3x EBITDA, a figure that has been rising since 2011 when it was just 0.1x. However, first-lien is also continuing to rise as well, reaching 5x EBITDA in the quarter, up slightly from 4.9x in 2017.

Financing that made use of bonds in the structure also grew, increasing to 24.4 percent in 2018 so far, compared to 21.3 percent in full-year 2017 and 17.2 percent in full-year 2016. High-yield bond volumes have been growing fast, according to LCD, with €24.8 billion of sponsor-backed high-yield bond issuance in 2017, the second highest amount LCD has seen since it started tracking issuance in 2006.

LCD’s research also found senior-only sponsored deals have much lower leverage than transactions with subordinated debt. Non-senior-only deals are leveraged an average of 1.3x higher than senior debt since 2014, reaching 1.4x in Q1 2018.

Senior-only deals also tend to be much smaller, with the maximum size so far in 2018 reaching just €860 million, compared to €3.9 billion for other deals. Among senior-only leveraged buyouts, maximum deal size is also smaller at €833 million, though the differential is less, with other LBO deals peaking at €1.7 billion.