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

Leveraged finance: The United States versus Europe

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  • 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

Leveraged finance markets in the US and Europe reacted to the impact of COVID-19 in much the same way through the course of 2020. Both experienced a steep decline in activity when lockdown measures first came into effect but then saw combined high yield and leveraged loan issuance return to relatively healthy levels by year end. Despite the uncertainty and dislocation, both markets revived swiftly through the second half of the year, setting the stage for a busy 2021. Pricing in the secondary market has recovered, as has M&A activity.

As for COVID-19, infection rates in Europe remain a risk, with further lockdowns and restrictions being implemented. The rollout of vaccines, however, has given all markets confidence, with the Dow Jones and the MSCI Europe back in the black.

The increase in high yield issuance in the United States in 2020—in Europe, high yield bonds rose by 10%



Up and down and up again

After a volatile 2020, leveraged finance markets in the US and Europe are poised for a more stable year. Both experienced a rollercoaster of activity in 2020 before rebounding in the second half of the year, restoring a much-needed sense of normalcy to the markets and setting the stage for deals in 2021.

The leveraged loan market in the US, for example, was particularly robust at the start of 2020, with January issuance of US$125.1 billion—up 70% on the US$74.5 billion figure recorded for December 2019, according to Debtwire Par. This momentum carried into February, with issuance of US$139.2 billion, before activity more than halved in March to US$65.3 billion and then dropped further still in April to US$41.4 billion.

Institutional loan issuance in the US saw an even deeper decline, dropping from US$103.5 billion in February to US$27.8 billion in March and US$17.6 billion in April. 

Despite concerns about this extreme decline in activity, leveraged loan issuance in the US came back to hit US$65.6 billion in June and then climbed to US$73.3 billion in September before peaking at US$88 billion in December.

By year end, data from Debtwire Par shows leveraged loan issuance in the US totalled US$861.73 billion, a 4% year-on-year decline but still far healthier than many expected after such a turbulent year. Institutional loan issuance, meanwhile, climbed 11% year-on-year, despite the fall in activity during the spring.

The European leveraged loan market, similarly, had a steady January and February according to Debtwire Par, with leveraged loan issuance of €29.6 billion and €26.2 billion respectively, before COVID-19 uncertainty saw activity fall significantly in March 2020. In June and July, European leveraged loan issuance bounced back to €33.7 billion and €23.1 billion respectively, in line with figures earlier in 2020. By the end of the year, the European leveraged loan market was up by 11% year-on-year to €227.1 billion.


High yield surge

The patterns for high yield issuance in each region followed a similar path. In Europe, high yield activity more than halved in February, at €6.6 billion, down from €16.5 billion the month before, before completely shutting down in March with almost zero issuance, according to Debtwire Par. But by the end of Q4 2020, it was up 10% year-on-year to €100.5 billion.

This shift in fortunes was even more pronounced in the US high yield market, with issuance at US$34.8 billion in January before dropping to US$4.5 billion in March. By the end of 2020, however, a surge in activity meant the US high yield market posted a 69% year-on-year increase to US$428.3 billion.

What was behind these dramatic turns? Borrowers scrambling to secure liquidity as secondary market pricing was falling, with everyone assessing all available options to strengthen their balance sheets.

The vast government stimulus of the CARES Act in the US and various state-sponsored employment retention and rescue loan schemes in Europe gave a degree of stability to both economies. Initially, leverage tests and dividend restrictions limited the use of these packages for leveraged borrowers, although steps were taken subsequently to open up these support loans. Many borrowers turned to the US high yield bond market for liquidity, where issuance more than doubled, quarter-on-quarter, to US$151.1 billion in Q2 2020— its highest quarterly total in five years.

The US Federal Reserve's move to buy corporate bonds cemented the recovery of the US HY bond market. So too did its move to cut rates, which made fixed-rate bonds more attractive than floating-rate assets.

The rise in US high yield issuance was also partly a result of a slowdown in the leveraged loan market, where bank balance sheets were stretched following substantial drawdowns on revolving credit facilities. According to S&P, US borrowers drew down US$274.9 billion from credit revolvers between March and May.

With the loan market restricted, the appetite for deals among US high yield bond investors was strong, especially if issuers offered security. The market share of secured bond issuance climbed to around 45% in Q2 2020 from around 30% in Q1 2020.

The US high yield market was also supported by the Federal Reserve's decision to continue buying the bonds of 'fallen angels' (credits downgraded from investment-grade to 'junk'), which injected further liquidity into the US high yield space.

European high yield markets also reopened in Q2 2020, but took longer to rebound. Issuance in April and May was still in the low single digits— volumes only showed a noticeable increase in June, rising to €16.2 billion.

Unlike the US, the bond buying programme of the European Central Bank (ECB) did not include scope to invest in fallen angels, but the ECB did loosen rules to allow banks to offer fallen angel bonds as collateral when accessing ECB liquidity. Normally, collateral had to be investment-grade.


Markets recover and M&A returns

The pace of recovery has been swifter in the US, with GDP rebounding 33.1% in the third quarter of 202016 versus 12.7% for Europe17— and signs are that this will carry into 2021, which will give companies and investors alike cause for optimism.

M&A also revived in the US, with values climbing more than five-fold from Q2 to Q3 2020. In Western and Southern Europe, M&A values more that doubled over the same period. The US election provided some additional stimulus for M&A, with US dealmakers moving to clear pent-up demand and get deals done. European dealmakers were more cautious, with the risk of new waves of infection and further lockdowns moving onto the horizon earlier than in the US.

All in all, the signs of recovery in the debt markets in both the US and Europe far outweigh the negatives, with companies and investors alike eager to put 2020 behind them.


16 "U.S. economy grew at an unrevised 33.1% rate in the third quarter". Reuters staff. 25 Nov 2020. Reuters.
17 "GDP up by 12.7% in the euro area and by 12.1% in the EU". Press release. 30 Oct 2020. Eurostat (PDF download).


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


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