The flight to quality in European emissions
In March 2020, as foreclosure restrictions took hold, European leveraged financial markets came to a momentary halt. Like our latest report on leveraged finance reveals, many feared the worst, as leveraged loan issuance declined significantly that month and high yield bonds saw virtually no activity.
Borrowers and lenders have held their breath, cleaning up their finances and waiting to see what might follow.
And then, just as quickly, investor sentiment started to improve. By the end of the second quarter of 2020, global emissions had returned to pre-pandemic levels. And while activity slowed in the second half of the year, as new waves of COVID-19 swept across the UK and Europe, the final tally confirmed the long-term resilience of the market.
High yield bond issues also held up, rising 10% on 2019 figures to US $ 113 billion– and may well retain the market share gained through loans during the year 2020, especially lower in the capital structure, with high yield unsecured bonds at competitive prices compared to second-tier debt. rank.
Loan and bond prices widened in 2020, and despite tightening in the fourth quarter, lenders expect prices to hold their favor in the coming months as fewer opportunistic credits hit the market. market for a revaluation than in previous periods.
Average yields to maturity on high yield bonds widened from 3.8% to 4.7% over the year, while average margins on leveraged institutional loans increased by 338 points basis in the first quarter of 2020 to 401 basis points in the fourth quarter.
There are several examples of transactions that raised financing but at higher prices, including Creed Fragrances, owned by BlackRock, which priced an institutional loan of € 250 million at 5% compared to Euribor, and Building Materials Europe, backed by Blackstone, which obtained a 220 million refinancing at the same cost.
In loan markets, lenders have achieved further price improvements through larger initial issue discounts (OID – the discount from face value at which a loan is offered for sale to investors) and, in some cases improved LIBOR floors. The share of new loans with OIDs of 99 and below increased during the year, accounting for more than a quarter of new transactions.
Regarding LIBOR floors, which lock in a minimum interest rate for borrowers even when interbank lending rates fall, the share of loans with floors between 0.5% and 1% increased slightly in 2020, even if the 0% floors still represent the bulk of emissions.
Government measures reduced restructuring
As new waves of COVID-19 pose continuing challenges to the market, the deployment of vaccines, along with a change of administration in the United States, has raised hopes for improved business flows in 2021. Broad quantitative easing programs introduced by the Bank of England and the European Union The Central Bank has injected large sums of liquidity into the capital markets, which banks and investors will tap into.
Additional employment support programs from the European government – which received applications from more than 40 million workers – and various state-guaranteed loan programs brought more liquidity to the market at a time when it was needed. most needed, injecting billions into European economies.
These measures, combined with low interest rates, have allowed many lenders to get their capital deployment goals back on track. Government and central bank action also supported existing credit during the most volatile parts of the year, meaning that many borrowers were able to avoid restructuring scenarios. As a result, only 3.6 billion US dollars leveraged loan issuance has been secured for restructuring in 2020. Restructuring activity, however, could increase further as government support measures unwind.
Rebound in buybacks on the horizon
The value of private equity deals in Western Europe hit its lowest level in the second quarter of 2020, totaling US $ 32.3 billion—The lowest quarterly figure since the third quarter of 2013, according to Merger market The data. The volumes of private equity transactions for the year, meanwhile, decreased by around 10% in one year.
This interruption of private equity activity following the lockdowns of COVID-19 weighed heavily on the LBO debt issuance. Even though the issuance of European high yield bonds for LBOs has been strong—more than 35% year after year, the region’s much larger leveraged loan market has seen Decrease in LBO issues over the same period, according to By debt. However, the activity of financial sponsors bounced at the end of the year, pointing to an improvement in the flow of transactions by 2021.
Despite all the uncertainties imposed by COVID-19, lenders remain keen to deploy capital. This has been true throughout 2020 – when the limited deal flow and LBO deals hit the market, appetite was strong.
Banks that took out debt for the € 17.2 billion carve-out of ThyssenKrupp’s elevator division by Advent and Cinven, for example, were able to sell € 8 billion in loans and bonds to fund the deal, despite the uncertainty surrounding the pandemic. The banks behind TDR Capital-backed Stonegate pub chain, meanwhile, sold £ 1.2bn of bonds in July to finance Stonegate’s takeover of UK’s largest pub operator, Ei Group. .
Europe Agreement activity could take off in 2021, but sponsor-buyers and financial lenders could remain very selective – they will likely cluster around high-quality assets and distressed companies, where investors can invest in sectors directly affected by lockdowns at low valuations.
CLO: A simple wound of the flesh?
European Secured Loan Bonds (CLOs), meanwhile, went through the worst of the cycle in 2020, despite COVID-19 uncertainty, credit downgrades and loan price volatility, with CLO managers returning. in the market to gain investor support and resume normal trading after the start. of the pandemic.
The volume of new European CLO issues in 2020 fell by around a quarter year-on-year, according to By debt. CLO refinancing played a big role in this drop, falling to zero in 2020.
Some may have feared the worst when the prices of leveraged loans plummeted, but CLOs have shown once again (as they did in the aftermath of the 2008 recession) that they are designed for. operate smoothly throughout economic cycles. In October 2020, the main CLO new issue market was nearing full swing, when € 4 billion in new CLO issues were valued across 12 deals, the highest monthly level since October 2019. Vaccine News have given new impetus to European markets, with Reset and refinancing activity expected to return to Europe in effect in 2021.
CLOs also held up due to other features of the product structure, including typical requirements for 90% of a portfolio comprising senior secured loans, portfolio diversification by borrower and sector, restrictions on illiquid loans and the growing importance of environmental, social and corporate governance (ESG) criteria, which have protected CLOs from investments in riskier sectors.
What does all of this mean for 2021?
First, the influence of COVID-19 will continue to be felt, even as vaccines are rolled out across Europe. Sectors affected by the first wave, including entertainment and recreation, hospitality, retail, oil and gas, and aviation, will struggle to secure funding, having already done what they can. to survive.
Within these sectors, those who need financing and are able to strike deals will likely have to pay for this privilege, with leveraged debt becoming more expensive for those whose credit has been hit or is only available. ‘under more stringent conditions.
Second, and in contrast, lenders will turn their attention to high-quality credits or sectors that have found new avenues for growth during COVID-19, such as technology and healthcare. Lenders will mitigate risk by analyzing transactions even more carefully for quality credit, which in turn will affect prices. Any weaknesses or gaps in the documentation will be investigated and lenders may be more careful in their forecasts.
For the most part, lenders have responded to the pandemic as a short-term, albeit undeniably dramatic, concern. According to the industry, companies that were considered trustworthy credits before COVID-19 continued to be seen as trustworthy, and this was reflected in the change processes in 2020, which tended to focus on liquidity. and improved reporting in conjunction with a reset or suspension of covenants.
Third, as we have already seen in 2021, loan supply has become a hotly contested market for good loans, and we expect this to continue. For these well-positioned companies, this flight to quality will continue to offer favorable terms and prices, and the lightweight commitment packages that were the norm before the pandemic are expected to remain in place with continued pressure for more aggressive terms. We expect to continue to see a liquid market for primary issues, refinances and revaluations, perhaps sprinkled with a few dividend recaps.
And finally, the issues that were in mind before the pandemic will continue to influence borrowing and lending decisions, especially ESG factors – investors, issuers and underwriters all have a positive view of credits that incorporate of ESG criteria significantly. This will undoubtedly boost this trend in the coming months as the recovery takes hold and global debt markets return to growth.
After years of warnings about maturity walls, looming cliffs, interest rate cuts and hikes that did not happen, COVID-19 was the event that temporarily brought everything to a halt, but there is every chance that the markets will remain very competitive and active in the months to come.