Leveraged finance in Peru: liquidity issues create a changing dynamic
Decreased availability and increased costs of funding have altered the behaviour of borrowers and lenders in the Peruvian leveraged finance market. Thomas Thorndike of Garrigues highlights the main themes and considers the outlook
Debt pushdown and/or the possibility of refinancing have traditionally been key to leveraged finance transactions in general, and especially in Peru. However, increasing inflation and interest rates (in both cases, from a global and local standpoint), as well as economic downturn and political unrest in Peru, have lowered the availability of liquidity and funding in Peru in 2023, indirectly changing the maturities, amortisation schemes, types of financing, and collateral structures being used for leveraged acquisitions of Peruvian assets.
Typical structures used to be for shorter tenures than those seen today, and included longer grace periods for principal amortisation, as well as – in most cases – balloon or bullet amortisation schemes (classic bridge-to-market structures).
Although greater principal amounts continue to be pushed towards the end of the amortisation schedules, amortisation schemes have recently tended to be more linear than before.
Given the liquidity issues alluded to above (availability and costs), banks are requiring or seeking further support or collateral from sponsors, which is certainly not customary in leveraged finance. Although in most cases there has been pushback, some sponsors (often non-financial) have agreed and been more flexible.
Borrowers and lenders
Borrowers’ reactions to interest rate hikes and other macro shocks have varied depending on the target being financed and the type of sponsor.
Corporate sponsors have been more flexible in accommodating less traditional leveraged financing structures, in order to cope with the current financial markets and terms when they identify a target they really find strategic, while financial sponsors keep pushing for traditional leveraged financing terms.
When having to refinance due to tenures, borrowers (both corporate and financial sponsors) have accepted more expensive refinancing alternatives to take out typical leveraged financing transactions, with a view to refinancing within the next few years in the hope of having cheaper and less stringent financing options available.
Lenders that were not recurring players in leveraged finance have reduced their appetite for these types of deals, while lenders that were typically active and were not averse to leveraged finance risk have continued their offering (reflecting current market conditions and pricing), being increasingly careful on their risk analysis, though.
With regard to terms, as mentioned above, lenders are being much more careful with their offering for leveraged finance deals in Peru, except for cases involving especially interesting or attractive targets and/or key sponsors, with which they have felt more comfortable with classic structures.
Future challenges for the leveraged finance market
The effect of political risk (with Peru enduring political turmoil in 2023) and climate risk (as the country faces climate issues that affect key industries due to the ‘El Niño’ phenomenon) in Peru, as well as inflation and growth projections for the country in 2024 (to analyse target performance and local credit risk), will be significant factors in the leveraged finance market.
Notwithstanding the above, the inflation and growth rates projections for the US, China, and the EU will also be key, particularly from a liquidity standpoint for lenders, as well as in their assessments of funding costs and refinancing risk.
Types of transactions and market predictions
Bridge-to-market structures or shorter-term deals, with bullet or balloon amortisation schemes, have not been as frequently used as in the past, given the lack of liquidity and/or the funding costs in the market in general.
There are signs of improvement, in the form of more activity and increased availability of structural alternatives to finance acquisitions, given that the political situation in Peru seems to have stabilised and M&A activity is positive; however, the global liquidity, inflation, and capital market conditions will be key.
There has been less activity in liability management recently, as – given the cost of funds and lack of liquidity, as well as the macro conditions of Peru – borrowers only tend to refinance their current funding structures if it is really necessary, due to tenures or other conditions.
Borrowers will have to be ready to confront more costly and challenging conditions should they face a ‘hard’ necessity to reach out to the market for liquidity (to pay for targets or refinance existing acquisition debt). For lenders, careful evaluation of market conditions and the risk in deals will be vital.
Alternative sources of capital
Corporate borrowers have tended to use corporate financing and/or cross-collateral structures to finance acquisitions (as opposed to the typical leveraged finance structures), while financial sponsors (particularly large international institutions) continue to push for traditional structures where repayment risk is focused on the target’s ability to take on the debt and/or be included within refinancing schemes.
With regard to fund and liquidity providers, there has been a much larger presence of international debt funds (senior and mezzanine) targeting borrowers in transactions – including leveraged finance – that have typically been financed by banks.
Given the high interest rates at present and banks’ tendency to be more conservative when taking on risk, international debt funds – which are typically much more expensive than banks, and usually appear in deals of distressed or overleveraged companies – have appeared much more frequently as sources of capital in recent times.
There has been a growth in ESG financing, but only with respect to project financing transactions, or, in the case of leveraged finance transactions, in those involving special purpose vehicle targets that are building and/or operating infrastructure and energy projects.
Regulatory reform and benchmark change
Recent regulatory reforms have focused on corporate governance, anti-money laundering, and compliance requirements for financial institutions and in general.
Lenders and borrowers have adjusted quite well to the transition from LIBOR, mainly though agreed amendments to shift to term SOFR, and not by using hard-wired mechanics built into existing LIBOR-based credit agreements.
Financial assistance rules for corporations in Peru have been analysed in past years, and it is expected that if eventually a corporate law reform comes along, it would include changes to financial assistance rules and restrictions that may apply to leveraged finance transactions.