Leveraged Finance Outlook: Market Participants Prep for Busy Primary Issuance in 2025 Boosted by Increased M&A, LBO Dealmaking

Leveraged finance participants say they expect 2025 will usher in a long-anticipated boost in M&A and LBO activity that will bolster the debt capital markets.

Although many investors and bankers were hopeful of an uptick in M&A activity in the start of 2024, those hopes never materialized. But 2025 will bring a technical, economic and regulatory backdrop that will support an increase in activity beyond the “wishful thinking” that fueled predictions in previous years, according to market participants.

“As a leading indicator, pitch activity for M&A and LBO deals is higher now,” said Tom Amster, global head of financial sponsors at Macquarie Capital, on his outlook of M&A and LBO dealmaking in 2025, in an interview with Octus. “Sponsors are driven by pent-up demand, technical pressure to both deploy and return capital and the perception of a more favorable political and regulatory backdrop.”

Additionally, Amster predicts that private equity sponsors will take advantage of strong debt capital markets to maximize leverage without the need to wait for additional rate cuts.

The spread on high-yield bonds was 268 bps as of Dec. 13, close to the tights of the year and more than 100 bps tighter than where they stood at the beginning of 2024, according to ICE BofA data. While high-yield bond spreads are at historically tight levels, all-in yields remain attractive, PineBridge Investments noted in a recent report. Meanwhile, the secured overnight financing rate is at 4.6% as of Dec. 13, tighter than 5.4%, where it sat at the start of 2024, according to New York Fed data.

Among other factors that will support new-money issuance, investors noted that the incoming Trump administration will be more pro-M&A from a regulatory perspective than the Biden administration.

“Not only is there a technical backdrop, a lot of private equity dry powder and strong economic background for more M&A activity, but I really think that the policy change with the incoming administration will be the biggest factor in that uptick,” said David Forgash, head of leveraged finance at Pimco.

Robert Rahman, global head of the global corporate credit securities division at Dinosaur Group, said that the less onerous regulatory backdrop under Trump will support M&A funding via high-yield bond and levered loan issuance.

“The debt capital markets are going to have a banner issuance year in terms of net new issuance for high-yield and levered loans driven by a pickup in M&A volume,” said Rahman. He also noted that the LBO-financed portion of deal flow is expected to pick up both domestically and cross-border, compared with the below-average $7.5 billion financing reached in fiscal 2024 year to date.

Private equity and corporate M&A deal volume was up 17% year to date through September 2024 compared with the same period in 2023, said EY Parthenon in a recent note citing Dealogic data. The research firm estimates that total U.S. deal volume, including both private equity and corporate M&A, will rise 10% in 2025.

“While we’ve been anticipating an improvement in the leverage financed markets over the last two years, optimism for 2025 is even higher based on an expected rebound in deal activity,” said Amster.

With expectations for LBO and M&A dealmaking volume to increase, market participants say the credit quality of companies will also play a key factor in new deals coming to market.

“We expect more circumspection from lenders into sponsor deals,” said Hunter Hayes, chief investment officer at Intrepid Capital. “Volume will pick up overall, but the quality of the credit will get better.”

Primary high-yield bond and leveraged loan offerings financing LBO activity this year included deals such as Instructure, TenCate and R1 RCM.

Market participants also noted that recent deals in the leveraged finance market seem to be more investor-driven, with pricing coming at attractive rates for investors, indicative of a mindset shift among banks.

“We’ll see more risk-seeking behavior and flows in the fixed income space,” added Hayes. “Underwriting has now gotten sloppy – deals that cross the threshold of being healthy enough are getting massively oversubscribed. Anecdotally, it feels like we’re getting back into food fight territory – hairier deals are getting 5-6x oversubscribed.”

In terms of the debt financing structures for LBO deals to come, market participants say there will be demand for both high-yield bond and leveraged loan components testing both markets.

“Where a company will get better pricing in either bond or loan markets will go back and forth,” Forgash said. “But some companies that require leverage will want to access leveraged loans because they’re continuously callable and will offer more flexibility. While on the other side, if rates start going up a lot, these companies will wish they had more fixed-rate coupons, which is what unfortunately happened in 2021.”

Additionally, while CLO formation remains strong, Amster noted that there will be more institutional capital looking for a home, which should allow issuers to be aggressive. “We will see a bias towards leveraged loans more than high-yield, with the expectation of lower rates ahead,” added Amster. “That is the ultimate benefit with floating-rate debt.”

However, market participants hypothesize that rates will remain manageable into 2025, resulting in a continued low-spread environment for the high-yield market.

“Default rates will remain manageable for high-yield bonds and we will see a continued pickup in defaults for private levered loan issuers that generally have weaker credit profiles,” said Rahman. “We also expect a pickup in bondholder vengeance driven by more distressed exchanges and most investors trying to be on the right side of a given bondholder group representing a certain class of debt.”

Likewise, Janus Henderson noted in a recent report that it expects another positive year for high-yield, adding, however, that returns will more likely be driven by income as spread tightening wanes and gives way to more widening.

Nonetheless, as market participants wrap up 2024, many are already focused on what is ahead for 2025 and expect there will be plenty of companies coming to the primary to borrow.

“This market is not going to run into a shortage of paper problem,” said Rahman. “There will be plenty of leveraged credits to focus on in 2025.”