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


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

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European leveraged finance markets kicked off 2021 on a relatively positive note, with investor appetite pushing pricing tighter, robust demand from CLOs, continued inflows into high yield bond funds and the expectation of greater M&A and buyout activity following months of relative stagnation—all of which suggests the markets could see a burst of activity in the months ahead, as economies begin to open up once again.


A remarkable comeback

This optimism follows a challenging year for European leveraged finance markets, as COVID-19 lockdowns were imposed, loosened and then imposed again, and businesses scrambled for liquidity to shore up their finances.

Between February and March 2020, European leveraged loan issuance fell significantly. But by June and July 2020, it had climbed back up to pre-pandemic levels. And while issuance dipped again in the final quarter of the year, leveraged loan issuance overall managed to finish the year up 11% on 2019.

In a year that saw entire sectors effectively shut down around the world, from aviation to hospitality, leveraged loan markets came back to life much faster than many anticipated.

High yield bonds proved even more resilient, despite hitting rock bottom in March with almost zero issuance. By June, as initial lockdown restrictions began to ease in many parts of Europe, the market was back up to €16.2 billion—almost on par with January's figures. By the end of 2020, high yield bond issuance was up 10% on the previous year, as investor appetite for bonds remained robust.

European collateralised loan obligations (CLOs) followed a similar path. In 2020, new-issue CLO volume fell by 26%, with CLO refinancings dropping to zero, but by October 2020, primary CLO new issuance hit its highest monthly level since October 2019. News of vaccines provided another boost across European markets, with reset and refinancing activity expected to return to Europe in force in 2021.

€227 billion
The value of European leveraged loan issuance in 2020



Short-term thinking, long-term goals

This return to relatively healthy activity in leveraged finance markets has been bolstered by a pragmatic approach to documentation and terms. For the most part, lenders reacted to the pandemic as a shortterm, albeit undeniably dramatic, concern. Depending on the sector, businesses that were viewed as trustworthy credits before COVID-19 continued to be viewed as such, and this was reflected in amended processes in 2020, which tended to focus on liquidity and enhanced reporting alongside a reset or suspension of covenants.

For the time being, lenders will mitigate risks by analysing deals even more closely in search of quality credits—which will in turn affect pricing. Any weaknesses or loopholes in documentation will be scrutinised and lenders may be more cautious in their forecasting.

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


M&A and buyouts may bloom

Looking to the future, there are plenty of signs that Europe's leveraged finance markets will see robust activity in the months ahead, even as a new wave of COVID-19 lockdown restrictions are introduced.

Lenders still want to lend— encouraged by low interest rates and extensive quantitative easing—and borrowers are eager for financing. More transactions are likely to emerge, for example in M&A, with a clearer view of future earnings and pricing. The range of dealmakers and investment strategies is also likely to expand, from financial sponsors in search of new opportunities to activist investors driving deal activity.

This does not mean deals will be guaranteed, of course: Buyers and lenders will be increasingly selective, along sector-specific lines. They will focus on high-quality assets to minimise risks, as well as distressed companies, buying into sectors hit by lockdowns at low valuations.

Throughout the rest of the year, lenders and borrowers alike can expect to face unprecedented challenges, as COVID-19 restrictions rise and fall and vaccines roll out, but there is every chance that 2021 will also offer up unique opportunities for growth for those who take the plunge.


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


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