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On the retreat: investors steering clear of riskier assets in 2023

Debt issued in the institutional leveraged loan market is shifting back in the favor of BB facilities over B-rated tranches. So far in 2023, almost 40% of activity within these two groups has been BB rated, marking the highest percentage in the past five years for the safest assets in the sub-investment-grade space.

The bond market has followed a similar trend, with the share of debt issued as secured notes remaining at record highs of near 60% over the past three quarters. The historical average ranges between 25-45% in the past decade, highlighting the current move towards safer assets.

In both markets, leverage can be seen to be falling, with investors rushing towards safer assets, as lending on higher leverage ratios becomes unpalatable. Net leverage for 1H23 stands at 4.5x, while gross leverage is currently at 4.9x.

To compensate for their investments in these riskier assets, investors have been requiring higher yields on deals that have made it over the line so far this year. Yields on first-lien institutional loans jumped to an unprecedented 10.6% thus far in the second quarter, and the weighted average yield in the bond market stands at 8.7%. While this figure has decreased by over one percentage point from highs in 4Q22, the yield remains significantly above levels seen in recent years.Leveraged loan issuance pivots back toward safer instruments

New money, new lows

Despite the prevalence of higher yields, refinancing activity continues to be a cornerstone of the current market, with high-yield bond issuance skyrocketing to USD 34bn so far in 2023 – nearly double the same period last year. Refinancing is similarly buoying the leveraged loan market, rising 16% year-on-year despite overall leveraged issuance falling 30% to just under USD 300bn in the year to date (YTD). This shows that even with the headline figure of the leveraged market appearing solid, there is a marked lack of new capital being deployed in the sector.

New money issuance continues to slide
As a result of a lack of supply from M&A transactions, dividend recaps have started to resurface, as sponsors realise exit opportunities represent one of the few avenues available to them to achieve a return on their investment in the near term. A further USD 900m was issued for shareholder payments in April, bringing the total YTD amount to USD 3.6bn.
Considering the leveraged market in its current state, eventually something will have to give. Issuers are currently paying over the odds to refinance debt, pushing out maturities in the short term at exceptionally high interest rates, which are unsustainable over the long term. The market is in an eerie calm, with overall volumes appearing respectable. However, money being moved away from lower-rated assets, refinancing dominating issuance, and the lack of a solid M&A pipeline all point to an unsustainable market, with issuers set up to be unable to pay the higher interest rates demanded by investors for the risk taken.
If interest rates were to drop materially in the next few years to allow borrowers to refinance at manageable rates, then a material rise in defaults could be avoided. However, if the market remains in its current state, the ominous markers above suggest a difficult road ahead.
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Data Insight

Flourishing market: Sukuk driving Islamic financing in MENAT

The issuance of sukuk, Sharia-compliant financial certificates, ramped up in the first and second quarters of 2023 compared with a slower start in 2022. Issuers from Saudi Arabia, by far the largest market for Islamic finance, have led the deal spree, taking up 65% of all international sukuk placements so far this year. By contrast, the number of Islamic syndicated loans in the region has dwindled in 2023, with issuers seemingly rushing to take advantage of the deep liquidity on offer from sukuk investors. In 1Q23, there were only two USD-denominated Islamic loans signed, according to Dealogic, compared with seven in 1Q22. Just a handful of issuers, such as Bahrain’s Nogaholding, have delved into the Islamic borrowing space this year.

At the same time last year, nine issuers in the MENAT region had entered the sukuk market, according to Dealogic. So far this year, that number has grown to 14 names. This translates to around USD 20.6bn of sukuk in 2023 year to date (YTD) versus USD 8.7bn in 2022 YTD. One of the factors driving this activity, according to market participants, is the lower-than-expected number of transactions in MENAT last year, as issuers grappled with a choppy market backdrop driven by macroeconomic and rates volatility.

Now, as issuers and advisors alike see less volatility in the market, alongside an anticipation that the monetary tightening squeeze by major global central banks may come to an end, positive sentiment in the fixed-income market is more abundant, according to one Dubai-based banker. Pent-up demand for sukuk following suppressed supply in 2022, combined with a healthy pipeline of maturities, mean that investors are ready to deploy cash.

The market is developing innovatively, with more companies showing interest in issuing ESG-linked sukuk. Earlier this month, Abu Dhabi-based real-estate manager Aldar Investment Properties priced its debut green sukuk. In addition, market participants note that the sukuk private placement market is also growing in size, with names like Saudi Real Estate Refinance Company touted to be eyeing PP deals.

Sukuk issuance recovering from 2022; loans volumes look thin so far

Dominant force

Saudi Arabia has accounted for over 40% of international sukuk deals executed in the MENAT region since 2021. However, during the first five months of 2023, around two-thirds of all international sukuk cash raised in MENAT originated from the sovereign. In total, Saudi Arabia and its corporates issued USD 13.4bn of foreign-currency sukuk during the first five months of 2023 – a record since 2008. Almost half of this can be attributed to a jumbo sovereign dual-tranche placement of USD 6bn, which was priced on 15 May. Note, though, that this bond saw a negative one-day change of 1.62% after the closing price for the six-year notes and a 1.75% negative change for the 10-year notes, according to data from Dealogic.

Complex operating environment

While the deal pipeline for 2023 continues to fill, the need for additional financing depends to a large extent on oil prices. As the Organisation of the Petroleum Exporting Countries (OPEC) cuts oil production in an attempt to keep prices higher, Fitch forecasts 2023 Brent Crude at USD 83.5 per barrel (bbl). As at 2 June, Brent Crude was trading at USD 74.9/bbl. This should be enough to support the economy of Saudi Arabia, the largest sukuk issuer, which needs an oil price around USD 80.9/bbl to balance its 2023 budget, according to the International Monetary Fund (IMF). The current price should also support the economies of the United Arab EmiratesOman and Qatar, as the IMF estimates break-even oil prices for these countries at USD 55.6/bbl, USD 72.2/bbl and USD 44.8/bbl, respectively.

Further issuance from such sovereigns may be opportunistic, market participants say, given that issuance needs for many sovereigns – especially in the Gulf – are limited because of strong fiscal positions.

Bahrain, meanwhile, might need significant additional financing, as its break-even oil price is estimated at USD 126.2/bbl, significantly above the forecast provided by Fitch, while oil continues to take up a major chunk of GDP revenue (85% as of end-2021). Bahrain had a positive year in 2022, when high oil prices (USD 125/bbl at their peak in May last year) supported the contraction of the budget deficit to 1.7% of GDP from 6.8% in 2021. The sovereign returned to the market in April this year, pricing a USD 1bn 6.25% 2030 sukuk and a conventional USD 1bn 7.75% 2035 bond at par. With Brent Crude set to remain below Bahrain’s break-even price, the economy is likely to need additional external funding.

Have yields stabilised?

While the average yield-to-maturity and average profit rate remain at historically high levels, they have dipped slightly to an average profit rate of 5.8% for MENAT issues priced this year from highs of 6.5% in 4Q22. At the same time, the average spread-to-benchmark has also returned to typical levels of around 212 basis points (bps) from a wider peak of 531bps in 2Q22. We see profit rates gradually declining further towards the end of 2023, as oil prices stabilise. According to one Dubai-based banker, spreads on GCC sukuk in particular have been relatively steady, moving within a range of 150-175bps. The drop in US Treasury yields since the start of the year has been the main trigger behind lower overall yields, and this is also encouraging issuers to launch new sukuk and lock in yields at lower levels than last year.

Spread-to-benchmark stabilises, while profit rates and yields on downward trend

What’s brewing?

As interest in the highly liquid sukuk market increases, the pipeline of new certificates is growing. A number of issuers in the Middle East, including AlmaraiEnergy Development Oman (EDO) and Abu Dhabi Islamic Bank (ADIB), are all considering their own public sales, according to Debtwire reports last month. Saudi Arabian Almarai has a USD 500m sukuk due in March 2024 that it could refinance ahead of maturity, while EDO may want to add a sukuk to its funding mix after recently renegotiating the terms of an existing USD 2.5bn loan, shedding USD 100m of interest. ADIB has an upcoming call date in September for its outstanding USD 750m AT1 sukuk that it priced back in 2018.

According to one GCC-based market source, there is a steady pipeline of deals expected to emerge before the last week of June, after which participants expect a more subdued atmosphere in light of the summer break.

As international sukuk gain momentum, interest in this segment has spilled over to other countries across the globe. In March, Air Lease Corporation, a US aircraft leasing company, priced its first USD 600m five-year international sukuk, with market participants commenting that the successful deal could entice other debut issuers from geographies that do not have established Islamic finance markets.

In April, Debtwire also reported that the Republic of the Philippines may be considering an inaugural international sukuk sale.

On 25 May, Malaysia’s sovereign wealth fund, Khazanah Nasional Berhad, returned to the sukuk market after two years, pricing a USD 750m five-year sukuk alongside a USD 750m 10-year conventional bond. The deal was more than seven times oversubscribed and attracted interest from over 200 investors, including some in the Middle East.

Overall, there is growing interest in the Islamic financing market, particularly sukuk, as a key source of financing, as demonstrated by the growing volume of transactions in the MENAT region. The product is gaining momentum and becoming more widespread, while at the same time finding support in new markets in Asia-Pacific and the Americas.

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Data Insight

Count down: high interest rates squeeze companies with EUR 428bn to refinance by 2025

The European leveraged market has a hefty EUR 428bn to be refinanced in the next two-and-a-half years, according to Debtwire data.

This vast amount is putting pressure on borrowers, who are likely to have to refinance debts at rates considerably higher than they originally were. The Eurozone rate for refinancing operations is currently 3.75%, its highest point since 2008, and professional forecasters surveyed by the European Central Bank predict it remaining above 3% until 2025. The case is similar to the Euribor rate, currently at 3.2%, used in floating-rate operations and as a benchmark for fixed-rate offerings.

This scenario is significantly changed from when these high-yield (HY) bonds and institutional term loans were launched. Between 2015 and 2022, the Euribor rate was always below 0%.

Debtwire data also shows the maturity wall peaking in 2026 and 2028, mainly thanks to the expiration of term-loan facilities. TLB volumes coming to maturity in these two years stand at EUR 125.9bn and EUR 178.3bn, respectively.

Considering TLB facilities commonly have a seven-year maturity, a significant part of these deals was printed right before and in the aftermath of the coronavirus (COVID‑19) pandemic, when key ECB interest rates were at 0%.

Outstanding leveraged debt peaks in three years' time


debt returns

Analysis of the use of proceeds of deals helps to understand what lies ahead. Debt raised to refinance existing facilities is by far the main use of bonds and loans with maturities up to 2028, accounting for between one-third and half of total outstanding debt each year.

This is followed by leverage buyouts (LBOs), which are prevalent in those deals with maturities further down the line, starting with only 14.5% in 2023, but reaching 31.1% on deals with maturity in 2028. The peak comes seven years after the post-pandemic boom in LBOs, when EUR 82bn was raised following the release of pent-up demand for private-equity acquisitions in 2021.

Data show that issuers of LBO debt are less exposed to near-term maturities. Some EUR 32bn of LBO deals are due to expire over the next six quarters. However, this is less than each of the next four years. In 2028, the LBO volume to mature reaches an eye-watering EUR 81.3bn.

LBO deal maturities are set to swell in 2028Top five countries' prominence increases

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