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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
Financial stock display

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
Financial stock display

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
Financial stock display

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
Financial stock display

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


What is shaping sponsor debt decisions for 2021?

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  • 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

COVID-19's impact on debt markets in the first half of 2020 has prompted financial sponsors to step back and reassess their debt-raising options.

At the start of 2020, leveraged loan markets were in good shape and continuing to provide finance on attractive terms. The onset of the pandemic, however, saw activity grind to a halt as banks and financial sponsors retreated to manage their portfolios.

Although leveraged loan activity showed signs of recovery in the second half of the year, issuance for leveraged buyouts (LBOs) was still down year-on-year, dropping 6% to €36.8 billion.

Commercial banks, meanwhile, have been stretched, managing existing books and dispersing government-backed COVID-19 rescue loans. In the UK alone, the government’s various bounce-back and business interruption loans paid out £69.1 billion in more than 1.5 million facilities. Banks across Europe saw similar levels of demand for other state-backed loan programmes, leading to reduced appetite and bandwidth for sponsor-backed deals by the end of 2020.

With these core private equity credit lines in dislocation, high yield bonds and direct lending moved firmly into the frame for sponsors.

The rise in high yield LBO issuance in 2020 year-on-year


High yield versus direct lending

High yield has been a clear winner, from a sponsor perspective, through the course of 2020. European high yield bond issuance was up 10% year-on-year to €100.5 billion. High yield LBO issuance in the region, meanwhile, was up 39% year-on-year to €7.8 billion. Sponsor-backed high yield bond issuance was up by 49% year-on-year to €22.4 billion by the end of 2020.

High yield bonds have always come to the fore in the absence of competition. When banks were reassessing their balance sheets and direct lenders were triaging portfolios, the deep pool of high yield investors, free from these considerations, could provide finance quickly—especially for higher-rated credits offering collateral or enhanced covenant packages.

After initially focusing on their portfolios, European direct lenders also saw opportunities open up early in 2020 as syndicated loan markets and banks retrenched. Direct lending was not immune to the impact of the pandemic, of course—data from Debtwire Par shows a fall in European direct lending volumes for LBOs from 189 deals in 2019 to 138 deals in 2020.

Although dividend recaps and refinancings by European direct lenders suffered significant declines in 2020, sponsors still found direct lenders open to financing LBO deals. The appeal of private debt as a predictable alternative to the more volatile syndicated loan market can also not be underestimated.

As syndicated loan markets locked up between March and May 2020, some arranging banks found themselves sitting with hung bridge loans—estimated to run into the tens of billions—that they feared they would be unable to refinance. Although this carried no immediate financial risk for sponsors holding portfolio companies with hung bridges, the inability to syndicate loans has always reflected unfavourably on sponsors.

Since the first round of lockdowns, a number of hung bridges have subsequently been taken out, including TDR Capital-backed Stonegate Pubs and ThyssenKrupp Elevator. Direct lending, however, could still serve as the best option to take out outstanding bridges or as an option to avoid syndication risk altogether, with direct lenders potentially attracted by the pricing caps on hung bridges, which offer higher margins.

Indeed, the growth of direct lending assets under management to US$1 trillion, according to Preqin figures, has seen direct lenders expand in scale and build capability to digest increasingly larger tickets.18

As mentioned earlier in the report, Ares Management underwrote the largest unitranche on record in June 2020, with the provision of a £1.875 billion financing package for Ardonagh, the UK’s largest insurance brokerage group, backed by HPS Investment Partners and Madison Dearborn Partners. The deal comprised a £1.575 billion unitranche loan and a £300 million committed capital expenditure facility.  

Larger platforms and institutions  are also moving into the space. Alternative assets manager Apollo and UAE sovereign wealth fund Mubadala teamed up to launch a US$12 billion direct lending platform that will invest in deals of up to US$1 billion in size. Mubadala has launched a similar initiative with Barings, while Credit Suisse and the Qatar Investment Authority have also established a direct lending offer.


Beyond the pandemic

The recovery in secondary loan pricing and a return of some stability saw leveraged loan activity return to healthier levels in the latter part of 2020. With the prospect of vaccines rolling out and a light at the end of the COVID-19 tunnel, the outlook for 2021 is brighter. Financial sponsors will no doubt turn back to leveraged loans to finance deals in the months ahead.

The resilience of the high yield market through the course of 2020, and the expanding scale of direct lending providers, who have the firepower to take on credits of increasing size, however, may prompt a sustained shift to these options long after COVID-19 has passed.


18 "Where does debt sit on the LP radar?". Op cit.



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