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European leveraged finance: COVID-19 and the flight to quality

What's inside

The European leveraged finance market remains resilient after a year of unprecedented hardship, as lenders dissect credits to determine the best possible deals, from pricing to documentary terms


As we enter 2021, COVID-19 continues to weigh on every decision, from our health to our work and our long-term plans and yet, despite these concerns, European leveraged finance markets have weathered the storm and remain positive about the year ahead

In March 2020, as lockdown restrictions took hold, the European leveraged finance markets ground more or less to a halt. Many feared the worst, as leveraged loan issuance dropped significantly that month and high yield bonds saw virtually no activity at all. Borrowers and lenders alike held their breath, shoring up their finances and waiting to see what might come next. And then, just as quickly, investor sentiment began to improve. By the end of Q2 2020, leveraged loan activity had returned almost to pre-pandemic levels.

And while it slowed somewhat in the latter half of the year, as new waves of COVID-19 swept across the UK and Europe, the final tally was up 11% on the year before—a remarkable achievement, confirming the market’s long-term resilience.

The story in high yield bond markets was equally impressive, ending the year up 10% on 2019 figures, with every indication that it will retain a larger share of the market in the months ahead.

What does all of this mean for 2021?

First and foremost, the influence of COVID-19 will continue to be felt, even as vaccines are rolled out across Europe. Sectors hammered by the first wave—including entertainment and leisure, hospitality, retail, oil & gas and aviation—will struggle to secure financing, having already done what they can to survive. Within those sectors, those that require financing and are able to secure deals are likely to have to pay for the privilege, with leveraged debt either becoming more costly for those whose credit has taken a hit or only being made available on tighter terms.

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.

Third, loan supply will continue to open up—but primarily for those that meet the right criteria. For those well-positioned companies, this flight to quality will continue to offer favourable terms and pricing, and the light-touch covenant packages that were the norm pre-pandemic should remain in place.

At the same time, an anticipated recovery in mergers and acquisitions and leveraged buyout activity will provide an additional lift in the early months of 2021.

And finally, the issues that were front of mind pre-pandemic will continue to influence borrowing and lending decisions, especially environmental, social and governance (ESG) factors—investors will take a positive view of any credits that incorporate ESG criteria in a meaningful way. This will no doubt drive this trend in the months ahead as recovery takes hold and global debt markets return to growth.

Living dangerously: How has European leveraged finance fared in the pandemic?

  • European leveraged loan issuance is up 11% on the previous year to €227.1 billion
  • High yield bond issuance is up 10% on 2019 figures to €100.5 billion
  • Average yields to maturity on high yield bonds widened from 3.8% to 4.7% in 2020
  • Average margins on institutional leveraged loans increased from 338 bps in Q1 2020 to 401 bps in Q4
stock market

Five trends driving post- COVID-19 documentation

  • Terms will move back in favour of borrowers/issuers (for now)
  • Lenders will hold the line in key areas
  • Forecasting and structuring will be a post-COVID-19 challenge
  • Pricing will continue to bifurcate by sector and rating
  • Competition will encourage private debt and syndicated markets to converge

Buyout rebound reflects optimistic outlook

  • Private equity deal value in Europe totalled €26.5 billion in Q2 2020, the lowest quarterly figure since Q3 2013
  • High yield bond issuance for leveraged buyouts (LBOs) in Europe is up 39% year-on-year to €7.8 billion
  • European leveraged loan LBO issuance declined by 6% to €36.8 billion year-on-year
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Market reset could trigger restructurings in 2021

  • In March 2020, credit insurer Euler Hermes forecast a 43% increase in insolvencies in the UK in 2021, as well as a 26% uptick in France and 12% in Germany
  • By December 2020, ratings agency S&P was forecasting European defaults rising to as much as 8% by the end of 2021
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European CLOs: A mere flesh wound?

  • New issuance of European collateralised loan obligations (CLOs) peaked at just under €4 billion in October 2020 from 12 deals—the highest monthly level since October 2019
  • European CLO new issuance declined 26% year-on-year, with refinancing volumes falling from €6 billion in 2019 to zero in 2020
  • By the end of March 2020, credit ratings on an estimated 10% of loans held by CLO managers were downgraded or put on notice of downgrade—however, the rate of loan downgrades eased and stabilised in the second half of 2020
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Sector split: The very different impact of COVID-19

  • Weighted average bids for healthcare and telecoms credits both priced at approximately 99% of par by the end of 2020
  • Entertainment and leisure and retail loans, meanwhile, priced in the 90% to 93% of par range
  • Between March and September 2020, only the transport and automotive sectors suffered more ratings downgrades and negative outlook changes than the oil & gas industry
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Leveraged finance: The United States versus Europe

  • In the US, leveraged loan issuance for 2020 totalled US$861.7 billion, a 4% year-on-year decline
  • The high yield bond market in the US saw a 69% year-on-year increase to US$428.3 billion
  • The European leveraged loan market increased by 11% to €227.1 billion year-on-year
  • The region's high yield bond market was up 10% to €100.5 billion

European leveraged debt in focus

Selected European leveraged loan and high yield bond markets by volume and value

What is shaping sponsor debt decisions for 2021?

  • Leveraged loan issuance for European LBOs dropped 6% year-on-year
  • High yield LBO issuance, however, was up 39% year-on-year to €7.8 billion
  • European direct lending volumes fell from 189 deals in 2019 to 138 deals in 2020
  • Ares Management underwrote the largest unitranche on record with the provision of a £1.875 billion financing package for Ardonagh


After years of warnings about maturity walls, impending cliff edges, downturns
and interest rate hikes that failed to emerge, COVID-19 was the event that brought
everything to a temporary standstill—but there's every chance that the markets will
explode with activity in the months ahead

Financial stock display

European CLOs: A mere flesh wound?

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The total for European CLO new issuance volume in October 2020— the highest monthly level since October 2019


  • New issuance of European collateralised loan obligations (CLOs) peaked at just under €4 billion in October 2020 from 12 deals—the highest monthly level since October 2019
  • European CLO new issuance declined 26% year-on-year, with refinancing volumes falling from €6 billion in 2019 to zero in 2020
  • By the end of March 2020, credit ratings on an estimated 10% of loans held by CLO managers were downgraded or put on notice of downgrade—however, the rate of loan downgrades eased and stabilised in the second half of 2020

European CLOs ploughed through the worst of the cycle in 2020, despite COVID-19 uncertainty, ratings downgrades and loan pricing volatility, with CLO managers returning to market to secure investor support and resume normal dealmaking following the onset of the pandemic.

European new-issue CLO volume in 2020 fell by 26%, year-on-year, to €22 billion—down from €29.8 billion in 2019. CLO refinancings played a big part in this decline, dropping from €6 billion in 2019 to zero in 2020.

Some may have feared the worst in March 2020, when leveraged loan prices plummeted, but CLOs have shown yet again (as they did in the aftermath of 2008) that they are designed to operate smoothly through economic cycles, to the point where we can say that the events of 2020 proved to be barely a flesh wound for the CLO market.

While, by the end of March, credit ratings on an estimated 10% of the loans held by CLO managers were either downgraded or put on notice of downgrade11, the rapid recovery of the leveraged loan market—combined with the ability of CLO managers to avoid riskier sectors and otherwise challenging positions—has already seen CLO portfolios recover significantly, both from a ratings and an over-collateralisation perspective.

Banks providing 'warehouse' facilities to CLOs—lines of credit that allow CLOs to buy up portfolios of loans before they are packaged into tranches and sold on to investors—were also cautious midway through 2020, as investor appetite for buying up CLO tranches waned. According to the Financial Times, between 40 and 50 'warehouse' lines were outstanding by the end of March 2020.12

But there have been signs of recovery since the first round of COVID-19 restrictions were implemented in the summer: The primary CLO new issuance market was back in near full swing by October 2020, when €4 billion of CLO new issuance was priced from 12 deals—the highest monthly level since October 2019. Liability spreads also tightened through the year, to the point where US-dollar deals have once again been marketed in Europe.

The start of the vaccine rollout in December 2020 provided another boost for markets globally, and the market expectation is for reset and refinancing activity to return to Europe in 2021, as has already been the case in the US.


Lessons learned

The resilience of CLOs is partly thanks to lessons learned following the 2008 financial crisis. Prior to the collapse of Lehman Brothers, which precipitated the 2008 credit crunch, CLO portfolios included a higher level of high yield bonds, and managers had longer windows in which to reinvest interest payments and proceeds from existing portfolios into additional loans.13 These structures were dubbed 'CLO 1.0'.

From 2010 onwards, however, CLOs adapted by narrowing windows for reinvesting proceeds, reducing or eliminating high yield bonds from asset pools and strengthening credit quality and support.14 These post-credit crunch vintages have been labelled 'CLO 2.0'.

CLOs have also held firm thanks to other features of the product's structure, including the typical requirements for 90% of a portfolio to comprise senior secured loans, portfolio diversification by borrower and by industry, restrictions on illiquid loans and the increasing prominence of ESG criteria, which have protected CLOs from investments in riskier sectors.15

COVID-19 has also sparked a new wave of CLO evolution. Although CLOs had a fair degree of flexibility when faced with restructurings, there were some restrictions on the ability of CLOs to 'follow their money' when their underlying credits have encountered distress. This has historically put CLO managers at a disadvantage in restructuring situations versus hedge funds, which do not face the same limitations.

Post-lockdown deals, however, have started to adjust, giving CLOs more room to take part in rescue financings and restructurings. According to S&P Global, a recent deal by CLO manager CVC included documentation that gave the company scope to acquire loans in default, insolvency or restructuring scenarios if the purpose was to mitigate losses. CLO managers Redding Ridge and GSO are reported to have secured similar terms.

In the immediate aftermath of lockdowns, CLOs also adapted by launching short-dated CLOs, with non-call periods of 12 months rather than two years, to take advantage of sharp drops in loan pricing in the secondary markets. Permira and Oaktree are among the managers who moved quickly to build portfolios of deeply discounted loans in the secondary market. By the fourth quarter of 2020, deals were back to the typical two-year non-call period and shorter reinvestment periods also became a feature of activity.


A focus on sustainability

In the midst of the CLO market's adaptation to the immediate challenges posed by COVID-19, the industry has also continued to make progress in the areas of ESG and sustainability. CLOs are an important source of financing for the US$100 trillion needed to deliver the 2030 Sustainable Development Goals. Banks are accelerating their underwriting of sustainability-linked loans, but need to recycle their capital by moving these loans into the capital markets via CLOs.

The G20's White Paper on sustainable securitisation (co-authored by White & Case) recommended that G20 central banks should start buying sustainable assets. This recommendation has been adopted by the European Central Bank, starting in 2021, which paves the way for the next-step change in the growth of the sustainability-linked loan market.

VodafoneZiggo's debut green bond issuance in December 2020 is the latest example of the largest leveraged issuers joining the sustainability party, and further evidence that this will continue to be an important driver of future CLO new issuance.


11. "Big banks left hanging after 'disaster' in risky loan market". Robert Smith and Joe Rennison. 31 March 2020. The FT.
12. Ibid.
13. "Seeing Beyond the Complexity: An Introduction to Collateralized Loan Obligations". Laila Kollmorgen and Steven Oh. 19 Sept 2019. PineBridge Investments.
14. Ibid.
15. Ibid.



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