How to invest in leveraged loans in today’s market environment
The European leveraged loan market, like other credit markets, suffered from a sudden and indiscriminate drop in market prices at the start of the Covid-19 crisis in March, resulting mainly from the lack of liquidity across all underinvestment markets and concerns about future downgrades. and an increased likelihood of default.
However, thanks to strong support from governments across Europe, prices have recorded an impressive recovery, which we feel somewhat disconnected from the most difficult macroeconomic environment that lies ahead.
A handful of companies have taken advantage of the relative strength of the market to issue new debt, mainly to lengthen the maturity of their existing funding. These issues (loans and variable rate notes) are priced 100 to 150 basis points higher than previous issues and have been well received.
On the other hand, from a macro perspective, as shown in the graph below, the European leveraged loan market has no short-term maturity wall to deal with as the economy and the market are still recovering.
In this context, we are maintaining a selective and prudent approach in the management of our funds.
Reactions of the Amundi portfolio
During the month of March 2020, Amundi European Leveraged Loans funds outperformed the market by 1 to 2%. We believe this can be attributed to the broadly diversified nature of the portfolios, a rigorous credit selection process and a focus on more defensive sectors.
While the market prices of these loans are likely to fluctuate over the coming months, we have renewed our focus on monitoring the financial strength and flexibility of each loan (especially liquidity), our position in the capital structure. (Senior Secured Debt), the legal framework of operation (law and country of the issuer) and our ability to negotiate the loan concerned. All these efforts are aimed at protecting the invested capital in the medium and long term.
To remember from the previous crisis
1) Increase in margins
Assuming that the evolution of the credit market after the 2008 GFC provides a relevant framework to enlighten us, we could anticipate how the markets might react after the crisis and during the reopening of the primary market for effect credits. the sink.
As for the period 2008 to 2010, we can expect an increase in margins: at this stage, we anticipate an increase in margins from 350 basis points to at least 450 basis points.
2) More protection documentation
Likewise, we might also see tighter loan documentation, perhaps with a lower share of ‘cov-lite’ loans after the Covid-19 crisis. Cov-lite represented more than 90% of transactions in 2019.
3) more conservative structures
We would also expect more conservative capital structures with lower leverage, as was reported after GFC when leverage was reduced by almost one turn between 2008 and 2010.
While these changes are positive for lenders, we remain confident that the leveraged loan market will continue to be a critical and attractive source of funding for leveraged buyout transactions due to the stability of the market and the the inherent flexibility it brings to capital structures.
Europe-focused Private Equity asset managers have a record level of capital to invest c. 280 billion euros in June 2019 (1). As in previous cycles, we believe that Private Equity sponsors will be keen to participate in Mergers and Acquisitions resulting from post-crisis corporate restructurings.
Reminder of the key characteristics of the leveraged loan
Leverage loans are senior secured debts positioned at the top of the capital structure providing good capital protection to investors.
As such, Leverage Loans are guaranteed on the borrower’s assets (buildings, intellectual property, patents, brands, shares in subsidiaries, bank accounts).
This “Senior Secured” status in the capital structure is also likely to offer better recovery because the debt has priority debts which take priority over other debts (unsecured debts, second privilege, mezzanine) and over equity. Over the period 2000-2017 (including the 2008 GFC), leveraged loans exhibited a lower rate of loss (i.e. cost of risk) than high yield bonds.
Amundi recently launched the second generation of its successful European bank loan fund. This successor fund is an open format, well structured to allow a cautious return to the leveraged loan market, taking into account the current difficult macroeconomic environment.
(1) Source: Preqin Pro, Preqin Global Private Equity & Venture Capital report, February 2020
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