20th May 2024

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What’s The Deal? | Tech Financing: A Goldilocks Scenario?  




Kathleen Darling: Hello, and welcome to the podcast. I’m your host today, Kathleen Darling, a member of our debt capital markets team. I’m excited to have with me today David de Boltz, a managing director with our leveraged finance capital markets team, covering technology, to discuss the current financing activities being seen in this sector. David, great to have you.

David de Boltz: Thanks, Kathleen. Delighted to be here.

Kathleen Darling: Before we start, can you walk our listeners through your background and roles held at JP Morgan?

David de Boltz: Yeah, absolutely. So I’ve been at the firm now for over 12 years, across multiple different roles, London, Luxembourg, New York. And since 2017 I’ve worked within the leveraged finance capital markets team in EMEA, covering technology, media, telecom and automotive sectors. And then purely switched to focusing just on the technology sector in New York for the last couple of years. If you think about the technology sector, it’s around 15% of the leveraged finance markets, but from a selfish perspective and what I cover, I think it’s the most exciting and fast-growing part of the leveraged finance space. And we work with companies across the spectrum, so think about it from early stage, negative free cash flow names, all the way up to pre and post-IPO, and all the way through to mature, large 20 billion plus tech companies looking to access the capital markets.

Kathleen Darling: Fantastic. To kick off, can you give an overview of what activity is being seen in the US leveraged finance markets related to technology? Specifically, it would be helpful to understand the market dynamics unfolding now.


David de Boltz: Yes, absolutely. So to understand where we are now, it’s worth quickly recapping the year what we’ve had in the technology space. So we came into the year with a clear pivot from the VC world all the way up to the public companies that the tech sector needed to pivot away from a growth at all costs to bottom line profitability. With the expectation we had of rising rates, the debt market was taking a very bifurcated approach between what we say, the haves and the have nots. 

And that really came down to the positive free cash flow companies, to put it very simply, having access to the markets, and the negative free cash flow companies, obviously having more difficulty coming into the market. And then we had the regional banking crisis bubble up, with tech at the very epicenter of that with the Silicon Valley Bank. And as a result of the volatility, we saw rating downgrades across the technology space. And just to put that into some kind of perspective, we saw a very sharp move in the cost of borrowing from technology companies from around the mid 8% all the way up to over 10% in only a two to three week period. So it’s an incredibly sharp uptick in the cost to access the markets. And it was really split between the haves and the have nots, if they could access the markets in its entirety.


So naturally at this point, we saw direct lenders actually take a significant market share away from the banks in the tech space specifically. And many of the tech private transactions were financed away from the banks in Q1. And again, to give you some perspective of the magnitude of that, 65 technology deals were financed by the direct lenders in the first half of the year alone, which is obviously an incredibly busy part of the market. But bringing you right up to the present day, demand from institutional lenders has actually snapped back so significantly that banks are now willing to enter into firm commitments with the expectation of being able to syndicate the term loans to institutional lenders. And the actual average price of technology loans has increased nearly three points since effectively late March. And that is a huge movement in the markets. 


Kathleen Darling: That’s really interesting, can you tell us more?


David de Boltz:  It’s down to two points. Point number one is the macro. The combination of this so called recession being less severe than previously expected. And then inflation under much more control. And then you have central banks pivoting, or the clear pivot coming in the coming months. So you have that on the macro side. And in the second side is really the technicals. You have the technicals in both the loan market and the high yield market. And when we talk about the technicals, we really talk about the supply and the demand in balance that we’re starting to see from the market participants.  The fixed income markets is a self-healing market, with interest payments, coupons received. And they really have not had that much to spend that cash on. And to give you perspective on that, the total financing activity this year is 70% refinancing. So very little new opportunities for institutional lenders to go and lend into. And what that means is with cash naturally building up, and supply being so low compared to where we’ve been in previous years, that’s really creating this Goldilocks scenario, where ultimately that cash needs to be spent. And so we are seeing that any new opportunities that we’re bringing to the market right now are being incredibly well received compared to only two, three, or even four months ago now. 


Kathleen Darling: You mentioned there needed to be a pivot away from growth at all cost, given the changing landscape in the macro and interest rate environments. Can you expand on this point? If it’s the case that investors and lenders are still factoring in a potential recession, how has this mindset impacted the willingness to put money to work? Is the preference still to deploy capital for higher quality, profitable tech names?


David de Boltz: Yes, you’re absolutely right, Kathleen. So investors in high yield bonds and lenders in leveraged loans are still very much concerned around the aforementioned potential recession that we could see over the next 6 to 12 months. But they’re also incredibly focused around the Companies that have over levered capital structures, who potentially have refinancing risk, or may need to come back to the market in the near future and raise more capital. So over the last three months alone we’ve seen 34 downgrades to CCC across both high yield and leveraged loans. And respect to leveraged loans especially, CLOs are actually trying to navigate proactively away from the capital structures that are starting to see pressure, to go down into the CCC territory. And actually what you see is a mini flight-to-quality amongst leveraged loans. The flight-to-quality that we typically see is sometimes from equities into gold, or from high yield into investment grade. But it’s a lot more nuanced than that in the leveraged finance side. What we actually see in loans is the navigation from B3 rated loans all the way up to B2, which sounds very small but it’s a massive difference in how CLOs can actually treat that capital as part of their lending thesis. And that’s where we’re seeing a large divergence right now in price. So the haves versus the have nots, you’re seeing a huge divergence in price between those names that are performing, and ones that are not. With respect to the leveraged finance markets, I will say those companies who were negative free cash flow who probably didn’t have access to the leveraged finance markets in Q1 or the early part of Q2. They’re starting to now have access once again. So lenders and investors from hedge funds, to real money mutual funds, they’re now starting to see what other opportunities there are to put some cash to work, and that ultimately leads to them going down the quality spectrum. And to the negative free cash flow tech names that’s actually potential… we’re gonna start to see that coming back into market again.

Kathleen Darling: Refinancings. We have started to see a theme of lenders willing to lend at par, or even above par, for high quality names. Can you talk about what is driving this? And if you expect this trend to continue now that north of 50% of loans are trading in the secondary market above 99? And to put this into context for our listeners, we have not seen this trend since April of 2022.


David de Boltz: Absolutely. So this really emphasizes the previous question. There is a trend developing around the higher quality companies, where they’re seeing a significant amount of cash and demand effectively chase all of the same opportunities. So you think around the demand in the system and the lack of new names coming to the market. Ultimately, that leads to the cash all chasing the same opportunities and this Goldilocks scenario right now where the mini repricing wave is just starting. And we’ve seen a number of tech borrowers actually borrow and cut their spreads on their leverage loans in the most recent weeks, which again, as you mentioned, hasn’t been seen for quite a while in the loan market. The more exciting outcome of the secondary levels improving so significantly is that many companies can borrow for small add-ons, whether that’s to fund general corporate purposes, or to even just replenish RCF drawings, when previously the upfront costs associated with coming to the market were so significant that the companies were shying away from coming to the market at all. So very much right now, the change in price is given not just repricing opportunities, but borrowers can now come back to the market and raise various different forms of lending activity, which is, again, three to four months ago, a very different place to where we are right now. 

Kathleen Darling: Moving from refinancings to M&A, the current underwriting M&A pipeline remains pretty subdued, with approximately 50 billion of committed financing. As we think about strategic and sponsored capital that is looking to be put to work, can you talk about what M&A financings you’re starting to see? As well as the appetite for larger underwritten holds?

David de Boltz: So, to put that 50 billion into historical context, at this point last year the streets underwritten bridge book, so the total amount of underwritten risk on the banks, stood at over 100 billion. We’ve cut that in half. And that really isn’t a significant number, and that’s not difficult for the market to digest. So very much it’s okay. And given the fact pattern, it is our view that the market is firmly open again for transformational M&A and LBOs once again. We’re actually starting to see activity really pick up in the background. And we actually, as a bank, underwrote over 8 billion of financing in the payment space in the last couple of weeks. So were really starting to see that activity pick up once again. And I would say the demand for transformational large cap M&A, is definitely back on the table. And lenders and investors are all very excited to put that cash to work in these large companies. I think what we’re starting to see, finally, is a match between the buyers and the sellers on the M&A side, which is then funneling into much more activity in the leveraged finance markets. And ultimately what people want to see is that supply and demand balance kind of rebalance effectively, so we’re not gonna see this repricing wave continue. Everyone’s very excited to see this.

Kathleen Darling: Last question, David, as we would be remiss without inquiring, artificial intelligence. We are certainly seeing the impact in the stock market, with seven tech issuers tied to AI leading the charge in returns. Are we seeing the AI impact in the debt markets as well? Or are we still in too nascent of a stage to gauge this?

David de Boltz: Yeah. This is almost the first question that we’re starting to see from lenders and investors, whether it’s in an update call, or whether it’s at a conference, AI seems to be on the touchpoint of everyone’s lips right now. And everyone wants to know what companies are doing about it, whether they are effectively trying to mitigate those risks form just being disrupted, their business model. Or now we’re starting to see them actually think about their opportunities and how they’re gonna take advantage of this. We’re even actually seeing it added to the risk factors in the offering memorandums as well. So there’s no shying away from the topic, but for now the market is very focused on a lot of what ifs, rather than taking investing views based on the AI wave. Venture capitals are still working out which horses are the right ones to back, whether that’s in the infrastructure, the date centers, et cetera, or the actual providers. So we may see some new subscription style models coming out in the near future. And we’re not gonna see these Companies come to the leveraged finance market in the short term, but I think it’s safe to say in the medium term we’re gonna see a wave of the AI backed technology firms coming to the leveraged finance markets pretty soon.

Kathleen Darling: David, this has been a great conversation on what we’re starting to see in the technology sector as it relates to the leveraged finance market. I think we’ll very much be interested to see where this trend continues going forward. So thank you for joining us.

David de Boltz: It’s going to be an exciting few months. Thanks for hosting, Kathleen.