Resilience and risks: Insights from the European Leveraged Finance Conference

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Daniel Rudnicki Schlumberger: Hi, you're listening to ‘What's the Deal,’ our investment banking series here on J.P. Morgan's Making Sense podcast. I'm your host, Daniel Rudnicki Schlumberger. I'm the head of Leverage Finance in EMEA at J.P. Morgan. Today, we're here to discuss the takeaways from our ninth European Leverage Finance Conference. This conference concluded on September 5th in London in our offices and featured over 1,800 participants, 90 presenting companies, quite a record. I'm joined today by Andrew Crook, the head of Leverage Finance Sales.

Andrew Crook: Hi, Daniel. Thank you for having me.

Daniel Rudnicki Schlumberger: And Daniel Lamy, our head of European Credit Strategy Research.  

Daniel Lamy: Hi Daniel.  

Daniel Rudnicki Schlumberger: Andrew and Daniel, thank you for joining me again. And maybe we can start with you, Daniel, to talk a little bit about the trends in the leverage finance market so far in 2025 and the main evolution compared to 2024 looks like quite a good year so far, doesn't it?

Daniel Lamy: It has been a good year. In fact, European high yield has returned 4% year to date, and it's done that in a relatively straight line, aside from in April when we had some pronounced volatility after the Liberation Day tariffs. What was quite remarkable was that the market recouped those losses within just 25 trading days, which is actually the second quickest ever rebound from a 3% drawdown in the last 20 years.  So the underlying market's in very good health. Spreads have tightened about 30 basis points a year to date in European high yield. They're sitting at around 300 basis points at the moment. Now, while that's quite expensive from a historical perspective.

Daniel Rudnicki Schlumberger: Expensive for investors…

Daniel Lamy: For investors, indeed, good value for your corporate clients and sponsor clients. It's really down to the strength of the underlying economy, which has been very resilient this year and has withstood some pretty big shocks, not just the tariff announcements, but a lot of uncertainty around geopolitics. What's also helped in Europe specifically is that you've had the loosening of the German debt break. And so the increased spending there is offsetting some of the tightening that you are seeing in other parts of the continent. And overall fiscal policy across the euro area, which was contractionary this year, is now going to be neutral to maybe even slightly expansionary next year. So that's a positive. And our economists are expecting growth in the euro area of around 1%. We're also seeing more demand for credit from a variety of sources, but most notably foreign institutional investors who, given the uncertainty around geopolitics, are looking to allocate more to Europe as a source of diversification away from some of the extensive U.S. holdings. That's something that we heard consistently from participants at the conference. And we're also seeing a lot of demand for credit risk from the retail side. The fund flow measure that we have maintained for a number of years has shown 8 billion euros of inflows since late April. That's on an asset base of roughly 100 billion euros. So quite a substantial inflow. There's also been a lot of CLO formation this year, excluding refinancing, CLO issuance has been around about 40 billion euros. So again, some very big numbers. And historically, when we've had index spreads above 4%, those inflows have tended to continue. We're currently looking at a yield of just over 5%. So all in all, from the demand side, very healthy. In terms of some other themes, what I found quite noticeable is that it's been a quality driven rally, at least in the last few months. So since June, double Bs, which are the highest rated portion of the market, have actually outperformed lower rated bonds. Triple Cs, which are the lowest rated, have lagged quite considerably. You've had some very large single name declines. On the index that we look at, triple C returns year to date are actually close to zero. So that decompression between high quality and low quality is unusual in a market that is trading so tight. But it is supported by the fundamentals that we're seeing.

Daniel Rudnicki Schlumberger: There's weakness at the higher levered end of the rating spectrum. Do you also see increase in default?

Daniel Lamy: So default rates have actually already begun to climb. That started in early 2023. And that was a response to the change in interest rates. So a lot of companies that had borrowed, you could say, too much in the low rate environment when rates reset higher found the interest expense unsustainable. Now, that's been a long process. And many of these interest rate sensitive companies are already now restructuring, have done so, or are close to finishing that process. So our own measure of default rates is around about 3.5%. We think that will climb potentially as high as 5.5% by the end of the year, which sounds very high. But it's driven by some very large capital structures. And I think crucially, it's already understood and priced in by investors. And the good news is that looking forward to 2026, we think the default rate could drop quite sharply next year as you move past these events. So we've put in a placeholder of 2.25% default rate for next year. And then depending on where we see the economy going, we could obviously change that one way or the other.  

Daniel Rudnicki Schlumberger: And for our listeners, these stats you're giving on default rates, is it across leveraged loans and high yield or is it just for high yield?

Daniel Lamy: So the numbers that we calculated for high yield, the leveraged loan default rates in Europe are a little harder to measure, but the numbers that we've seen are a little bit lower. I think what we will find, though, is that the high yield default rate will come down next year, but the leveraged loan default rate might be starting to rise from, again, very low levels for a variety of reasons. It's probably going to take too long to cover in this podcast. But overall, we're reasonably constructive on fundamentals. There will be some pockets of stress, but it's just pockets.

Daniel Rudnicki Schlumberger: Constructive is probably, Andrew, also the theme amongst investors and lenders. I felt the mood was quite bullish at the conference.

Andrew Crook: I think that's right. And I think that's been the case for the lion's share of this year, notwithstanding Liberation Day and the short-lived wobble that came with that. I think just to add to Daniel's point around default rates, the investor expectation consistent with Daniel's view is that they remain relatively subdued in North America and actually decline from a high-ish base in EMEA, where, as Daniel said, they've already been elevated on a par-weighted basis due to some of the larger idiosyncratic issues. So investors think default rates are actually going to come down for a couple of reasons. There's been elevated distressed exchange activity, and that's resolved some of the problem credits. There's been a high level of refi globally that's pushed out maturity walls. And then something else that's very prominent in investors' minds is how diverse the different sources of capital are available to issuer clients now. So for example, there's $450 billion globally of private credit dry powder. It's a fairly broad definition, so not all of that is direct lending. There's some credit ops in there, but even still, the diversity of capital source is broader than I think it's ever been. With respect to the economy, in a word, the global economy remains resilient in the eyes of investors. In that context, investors see the dog continuing to wag the tail to an extent, like the U.S. matters most. Most recently, we've seen flash PMIs, U.S. retail sales, both come in above expectations. The Q2 GDP print was strong as well. And equally, investors for now appear willing to look through a weak payroll number last month. On inflation, which is a key offsetting consideration, there is less conviction. If anything, bilateral tariff extensions in the eyes of investors have reduced the sticker shock. However, it is expected to rise at least a bit as a result of a number of U.S. policies, the big beautiful Bill Act and immigration being two. Both of those are considered inflationary. In investors' minds in Europe, there is a resignation to below trend growth, albeit with a small amount of upside from the German fiscal tailwind, as well as some of the military spending commitments. Slowish growth, however, isn't feared by European investors in the leveraged finance community more broadly, for a couple of reasons. One, the inflation outlook is considered much clearer over here than it is in the U.S. And two, whilst the ECB has cut, it has room for probably another 50 basis points. So on balance, whilst it isn't Goldilocks by any means in Europe, it certainly isn't abject in the minds of leveraged finance investors. And quite frankly, that may be good enough.

Daniel Rudnicki Schlumberger: Okay, so where does that leave us Andrew now in terms of the investor appetite to buy new transactions? Are there pockets of focus? Are we talking about an across the board risk on appetite?

Andrew Crook: It's a good question. It's pretty broad, but it isn't without some nuance. So to do the question justice, you're gonna have to bear with me, I'm gonna have to set the scene a little bit. So we've already talked about investor expectations for the European and more broadly, the global economy. Taking it more asset class specific, the technicals in leveraged finance remain very, very strong. And that's absolutely front and center for investors in terms of how they think about the world. Flows have been very strong and consistent, both globally and across loans and high yield bonds. I've already mentioned the diversity of capital point, which is very relevant. There's 145 open CLO warehouses in Europe right give or take. There's almost double that number in the U.S. There were 28 warehouse registrations in Europe in July. That's the highest monthly total for any given month since 2021. A good number of those warehouses are actually backed by captive equity solutions. And this means that the manager can actually compromise on returns as they actually scale a platform. So while CLO arbitrage is tight, these warehouses should convert to priced and allocated CLOs and create a fairly consistent bid for the paper that you hopefully are able to supply investors with, Daniel. And then on the other side of the technical picture, from a supply perspective, a common refrain from investors is that they crave new money. That means non-refi related, so acquisition financing, divvy recap, or public takeout of private credit. And going on from that, I think in terms of digesting that technical, what does this really mean? So in primary, which I know you're particularly interested in, Daniel, we see very strong demand and elevated creativity from investors. They haven't lost all discipline, that said, even as they flexed on price. And I see a couple of areas where this discipline manifests itself. Firstly, high-yield bond investors still cover core protection. Secondly, on terms, investors are still willing to push back on some terms that they consider egregious, whether it's tariff-related exclusions from covenant calculations, co-op and LME blockers, or high-watermark EBITDA adjustments. And then a third area of caution, where they pause sometimes, is around issuer quality. And Daniel had talked a bit about this, but triple C risk in new issue format remains a challenge in Europe. There's been a small, small number of examples of low-quality supply in the last 12 months. Those that have braved it haven't always met the response they cover or necessarily traded that well on the break. Otherwise, investors are invariably willing to do the work. Europe's digested some very large transformational dividend recap trades. It's digested some private to public. It's digested some LBO financing, as well as a lot of cross-border flow. My point being that investors will look at a lot of what you're able to bring and what your issuer clients are able to bring. Dispersion is expected to rise slowly, creating a more forward starting opportunity set. And in the interim, some underperformance from some sectors is expected. A couple of sectors that were referenced to me this week included leisure, theme parks specifically, chemicals, oil and gas, albeit less of a default cycle there and more of a repricing cycle, and some of the healthcare names in Europe as well. On the flip side, investors are reasonably constructive on the re-militarization theme. So that means sectors such as infrastructure, satellites, defense and equipment rental. So Daniel, I have a question for you. This is something that's come up in a lot of panels this week. It's come up in a number of the round tables that we've done. M&A as a supply driver. We read a lot about it. We read a lot about sponsor pressure to realize DPIs. We read a lot about the backlog of sponsor-owned businesses. Our investors really need a thawing of the M&A market. Can you tell us when it's coming?

Daniel Rudnicki Schlumberger: It's on its way. But 2026 rather than 2025 is probably the year. We're seeing good signs. We at J.P. Morgan have underwritten half a dozen new LBOs this summer. We haven't had such a good level of activity since 2021. That's a good sign. But the volumes of net new M&A are still reasonably small. Year to date, we've had quite an impressive run of leveraged loan and high yield issuance in Europe. We're actually on track to beat 2024 and 2021, our two previous record year. We're running about 20-25% higher than 2024 in terms of volumes. It's 80% refinancing focused. We're getting new mandates almost every day to market, which is ripe for repricing in leveraged loans. The first week of September has been quite good. We've seen eight new issues in the high yield and leveraged loan market. We are not yet going to see massively increased M&A, new money related volumes. Actually, out of a 25 billion visible pipeline, only a third is M&A related. So it's getting better, but slowly. What about you, Daniel? You're, bravely, giving forecasts for issuance volumes and spreads for the full year. Where do you stand now?

Daniel Lamy: Well, we have made some changes recently. In terms of supply, we think that activity over the rest of the year will slow a little bit from the very, very heavy pace that we had, particularly in the high yield market in May through July, which was actually a record for a three-month period. But it's not going to slow that much because of some of the things you've mentioned, Daniel. So refinancing has been a big driver of supply this year. We think that will continue. Although, when you look at what is left to refinance over the next couple of years, the stock of maturities, at least callable bonds where that refinancing can be done quite early, that is starting to diminish. So if you look at, for example, callable single B paper maturing by the end of 2027, that's shrunk to just 20 billion euros. So there's more to do, but it's going to, over time, slow down. But given that we're in this lower rate environment than we were 12 months ago, and spreads have tightened to very tight levels, expensive for investors, as you said, but cheap for issuers, we could see some net new money supply on the corporate side. So companies just wanting to put some cash opportunistically on balance sheet. And the dividend recap activity has been one way that sponsors have been able to extract some cash in a market where IPO volumes are extremely low. All of those things together, we've got a forecast for high-yield bond supply of 125 billion for the full year, compared with 87 billion at the end of August. On the loan side, there's even less refinancing needs, because a lot of maturities have already been pushed out. 2028 is the real jump in maturities within the maturity wall. But as you said, repricing activity is likely to continue to dominate. When you look at new issue margins over the last three months, they've been on average 370 basis points, which is only just inside the average on our index. But that's quite misleading, because half the market trades above par and is eligible for CLOs and will likely get repriced much tighter. And then the portion of the market that is trading below par, as we've mentioned, is not likely to be bought by CLOs. But there's still a huge amount of repricing activity that could be done. Through the end of August, loan activity, if you include new issue, amend and extend and repricing, was at 177 billion euros. We think that will end the year at 225 billion. Now, turning to returns and spreads. So we came into the year looking for a 5% total return in European high yield. We're currently around 4%. We increased our forecast to 6% earlier in the week. So we're expecting another two percentage points over the remainder of the year. We've got spreads ending the year at 330 basis points, so a touch wider than where we are to date, but some offset from lower shorthand rates because our economists expect the ECB to cut rates one more time in October. Now, what could cause spread widening? I think spreads are likely to remain very tight overall, but some of the macro data that we have, both the U.S. employment data and the inflation data, could nudge us away from the Goldilocks scenario that markets have been pricing in over the summer. But I would stress that unless we get back to a world where recession risk is really on the table, we think that high yield and leveraged finance is unlikely to reprice very much and will remain quite sticky at tight spreads.

Daniel Rudnicki Schlumberger: Andrew, what do you think are the main risks and opportunities for the market in the next six to 12 months? We've heard Daniel on what could widen spreads. What's your view?

Andrew Crook: So on the basis that spreads are tight, and I'm going to talk more about risks than I am opportunities, you may conclude that the leveraged finance market, at some point, risks becoming a little bit complacent. So I think you can bucket the risks into three or four main categories. Firstly, macro. They're the same risks facing all of fixed income. Rates fall, for example. It could come from rising government debt concerns and deficit concerns. That was a fairly common thread this week. There's no easy fix there. The market turns the other cheek until it doesn't, to an extent. Secondly, geopolitical risks. I mean, that's probably a topic for an entirely different podcast, but that's very difficult to forecast in the eyes of investors, but it's certainly omnipresent. Third, something that we haven't really talked about but is relevant, is an equity market correction. And by that, I think I mean that the market is wrong on AI. U.S. stocks have rallied 30% versus the liberation day lows. European indices have certainly benefited from some of the end of U.S. exceptionalism flows, as well as the fiscal thrust in Germany. So levels here are arguably elevated as well. a number of companies warning on a pause on AI hiring. A couple have mentioned the recent AI luminary warning around unsustainable pace to CapEx spending. Low cost Chinese alternatives, obviously, that reared its head in spring this year. And then as well, in a related point, U.S. access to rare earths and critical minerals. So that's a mix of AI and tariffs. In terms of leveraged finance specific risks, the cost of debt remains relatively elevated. So if we're all wrong on inflation, that would remain a concern. So I think more for now continue to signal the all clear than a warning of imminent stress. But I do see an accumulation of risks. I think in terms of opportunities, really more of the same. So by that, I mean quality carry. All in yields in the eyes of investors are deemed sufficient to compensate for any potential spread volatility. So I think I'm going to say what you want to hear, Daniel, which is investors crave supply because there's some new issued concession offered and they're ready.

Daniel Rudnicki Schlumberger: When you look at spreads, removing the 10% of most stressed capital structure or lowest rated capital structure, spreads are close to an all-time low.  So to recap, today we dived into the key takeaways of the 9th European Leverage Funds Conference. We explored market trends, investor sentiment, and future risk and opportunities. Big thanks to Andrew Crook and Daniel Lamy for joining me. Thank you to our listeners for tuning in to another What's the Deal episode. We hope you enjoyed this conversation. I'm your host, Daniel Rudnicki Schlumberger, and until next time, goodbye.

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This material was prepared by the investment banking group of J.P. Morgan Securities LLC, and not the firm's research department. It is for informational purposes only and is not intended as an offer or solicitation for the purchase, sale, or tender of any financial instrument.

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