The year 2021 is shaping up to be a strong and supportive one for leveraged finance, led primarily by merger-and-acquisition (M&A) and refinancing activity, according to the Capital Markets group at Mitsubishi UFJ Financial Group (MUFG).  

Key members of the group delivered their outlook for leveraged finance to reporters and editors at a virtual MUFG media roundtable earlier this month that featured Jeffrey Knowles, Co-Head of Debt Capital Markets; Grant Moyer, Head of Leveraged Capital Markets; and Art de Peña, Head of Loan Syndications and Distribution.

Accommodative factors for leverage finance heading into 2021

"We are at one of the greatest times ever to issue in the high yield market, especially if you're a double-B or single-B credit," said Mr. Moyer, citing this year's record-high issuance of more than $400 billion, as well as the BofA Merrill Lynch U.S. High Yield Index's record-low yield of 4.5% on December 4, which surpassed the previous low of 4.9% in June of 2014. "The world is awash with liquidity, rates are low [and] expected to be low for quite a long…time, and there's a tremendous amount of optimism as we look at potential vaccine effects of moving beyond COVID and as we look toward the middle of 2021."

Mr. de Peña attributes this optimism to "investors…on the bank side [and] the institutional side," who "give us…more confidence that we head into 2021 in…better…and more stable footing." He adds: "We've had solid demand [for leveraged finance] continue, and we've had a…conducive Federal Reserve that's providing a lot of support and backstops to some of these investors."

M&A and refinancing as key drivers

MUFG's Capital Markets group expects corporate M&A, private-equity buyouts and refinancing to drive the largest share of debt issuance below investment grade in light of narrowing credit spreads.

"What drives M&A is confidence level in the boardroom," Mr. Moyer said, adding that companies are willing to take on more debt in pursuit of acquisitions because they have greater clarity about the future improvement of their own operating performance, as well as the performance of potential acquisition targets. As a result, "I think we'll see higher leverage [in 2021]," Mr. Moyer said, though he noted that in some struggling sectors that have yet to recover from the pandemic—such as retail, travel and hospitality—leveraged buyouts will remain challenging and may entail more elaborate financing structures.

Mr. Moyer added that for companies undergoing bankruptcy, the current credit environment provides an opportunity to refinance debt at lower rates. "One of the things that happens whenever [there's] an [economic] downturn is [that] companies that were barely hanging on [file for bankruptcy]. [T]hat creates…an opportunity to recycle capital, streamline businesses, make them more efficient, and then create actual capital, investment opportunities and financing opportunities," he said. "Because there's so much liquidity out there, we've seen…companies come through bankruptcy with ample financing."

Mr. Moyer cited examples of companies that, in the course of bankruptcy, availed themselves to asset-based lending (which is secured by collateral such as inventory and receivables), and to a type of financing known as "exit financing," which allows a company to emerge from bankruptcy and restructure its business for efficiency. Through exit financing, debt owners can become equity owners and, in turn, provide a bankrupted company with capital, he said.

According to Mr. Moyer, the current environment will "create a lot of efficiencies and productivity gains in the overall economy," as well as refinancing opportunities through high-yield bonds and Term Loan B loans in 2021 and beyond. Mr. de Peña added that the current supportive environment for refinancing is "helping push back the maturity walls that we would have normally seen in 2022 and 2023," and that if liquidity remains abundant, then "default rates should [remain] relatively benign."

Risks to the outlook

Messrs. Knowles, Moyer and de Peña singled out a number of key risks that, if materialized, could undermine the prospects for leveraged finance next year. They include:

• a COVID-19 vaccine snag, such as a problem with the vaccine's distribution, the supply chain that makes its production possible, or its medical efficacy—each of which could derail or prolong the economic recovery;
• continued deterioration in U.S.-China trade relations; and
• the remote possibility of inflation or a sharp hike in interest rates, which would erode bond values and raise particular concerns for longer-maturity debt.

More dollar-denominated debt issuance in Asia

Mr. Moyer expects greater issuance of U.S. dollar-denominated debt in Asia due to higher expected acquisition activity, as well as the prevalent expectation that the U.S. dollar will continue to decline and thus become a more attractive currency for overseas companies in which to issue debt. "I do think we'll see more…Term Loan Bs and…[high-yield] bond activity" in Asia, he said.

MUFG is one of the world's largest financial institutions by assets, with approximately $3.3 trillion.