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U.S. Credit Markets

Junk-bond prices have rebound sharply in recent weeks, but many U.S. banks remain unwilling to underwrite new leveraged loans in support of M&A transactions.

While junk-bond pricing in the secondary market has rebounded sharply in recent weeks, many U.S. banks for the time being apparently remain unwilling to underwrite new leveraged loans in support of M&A transactions, according to a recent report in the Wall Street Journal.

The drop off in financing has been particularly problematic for low rated borrowers, where banks would be looking to the junk-bond market to cover part of the overall financing, as a number of lenders are apparently still carrying substantial loan inventory from highly leveraged deals underwritten over the course of the last six months. Banks that are supposedly backing away from new lending to debt-heavy M&A transactions include a number of players formerly active in this market, such as Credit Suisse, Wells Fargo and Jeffries.

With the diminished availability of financing for heavily leveraged deals, there has been a noticeable decline in deal flow for new mergers, with a drop of more than 20% in announced M&A deals so far this year, compared to a similar period last year. It has also tilted the playing field to the disadvantage of PE buyers, who typically rely on obtaining high-yield financing to complete transactions, and to the advantage of corporate buyers either armed with ample cash or financing backed by much stronger credit rating. The recently announced $9 billion all cash merger between Sherwin-Williams and Valspar is a good case in point.

There has been a continued strong appetite for well-rated merger-related debt, as evident from the successful recent issuance of $46 billion in investment grade bonds backing the merger of Anheuser-Busch InBev and SABMiller. As a whole, the high-rated end of the debt market continues to perform strongly, with investment grade issuance this year so far running slightly ahead of last year’s record setting pace, according to Dealogic.

Conversely, Dealogic reports that overall high-yield bond issuance this year is down 73% compared to last year. This may be further indication that the junk bond market as a whole faces problems of a more long-term and fundamental nature, as we discussed in a recent blog post. But whatever the underlying causes of the weakness may be, it’s clear this sharp reduction of junk bond issuance presents a serious obstacle to completion of larger highly leveraged merger transactions.

While the credit markets are shunning larger high-yield transactions, the financing outlook is more favourable when it comes to mid-market merger transactions, at least for those not dependent on access to junk bond issuance. As we previously reported, the loan market supporting middle-market transactions faced a major challenge last year when GE Capital put Antares Capital, one of the key lenders in the middle market, on the auction block. But with the dust settling on the sale of Antares to the Canadian Pension Plan Investment Board, Antares has apparently quickly re-established itself as a key lender supporting the middle market, last year closing on more than 188 senior loan transactions to PE backed deals, totalling more than $11 billion in commitments. So at least one important pillar supporting middle-market transaction financing has been re-established firmly in place.