European leveraged finance: COVID-19 and the flight to quality
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Sector split: The very different impact of COVID-19

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  • 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

Leveraged finance lenders have taken an increasingly selective approach in the wake of COVID-19, but quality credits in the right sectors will continue to receive favourable terms and pricing.

While the pandemic had a global impact on business, some sectors were hit harder than others. Lockdowns and travel restrictions had an immediate effect on the entertainment and leisure, hospitality, retail, oil & gas and aviation industries. Businesses in sectors like technology, services and healthcare, by contrast, continued to trade strongly through the course of 2020 and have been favoured by lenders.

Secondary pricing has reflected this sector bifurcation. Weighted average bids for healthcare and telecommunications credits, for example, both priced at approximately 99% of par by the end of 2020. Entertainment and leisure and retail loans, however, priced in the 90% to 93% of par range—though pricing in both sectors climbed from lows in the 85% range around September. These sectors, and others particularly affected by COVID-19, managed to outperform through the end of the year, though pricing continued to be affected.

The decline in global air traffic in 2020 due to the pandemic, according to the International Air Transport Association



Assessing sector filters

Under COVID-19, many lenders assessed sector exposure by broadly grouping credits into three categories: Those that were under financial pressure prior to lockdowns and whose decline accelerated as the pandemic spread; those that were solid credits pre-pandemic, but were hit severely by lockdowns; and those that performed well before and during the pandemic.

Physical retail fell into the first category, with euro area retail sales down despite strong performance from supermarkets and online retailers. The shutdown of 'non-essential' retail stores through lockdowns was too much for many businesses that were already struggling.

Liquidity lines have now run dry for many of these companies, particularly in the UK. Retail conglomerate Arcadia, for example, went into administration in November after unsuccessful attempts to secure a £30 million rescue loan from potential lenders. Department chain Debenhams succumbed to liquidation following two administrations.

The global oil & gas industry is another sector that was already feeling the pressure before encountering deep disruption under COVID-19, when lockdowns suppressed demand and hit oil prices even further. Between March and September 2020, only the transport and automotive sectors suffered more ratings downgrades and negative outlook changes than the oil & gas industry.

Bond markets remained open for European oil majors, including BP, Shell, Total and ENI, but smaller independents turned to alternative sources of funding. Reserve-based lending (RBL) facilities, which provide capital secured against a borrower's undeveloped reserves, offered oil & gas companies an additional line of finance. The size of these facilities, however, is reviewed biannually and determined by the price of oil. Oil & gas companies, therefore, have to keep a close eye on balance sheets to ensure that falling oil prices do not leave them at risk of default. FTSE 350 independent Tullow Oil, for example, reduced its RBL facility through the course of the year as oil prices shifted.

Oil & gas companies also had access to revolving credit facilities and support through COVID-19- linked loans from governments and central banks.


Long-term view

The situation facing companies in the second category, which includes aviation and leisure businesses, has been somewhat different. Despite being severely impacted by lockdowns, these credits were fundamentally sound and are expected to recover as COVID-19 restrictions are eased in 2021.

Lenders have been willing to take a longer-term view on such businesses. The global aviation sector, for example, suffered a 66% decline in 2020 air traffic, according to the International Air Transport Association. The sharp fall in bookings resulted in a swathe of European airlines having their credit ratings downgraded to high yield during 2020, including national carriers British Airways.

Airlines nevertheless continued to access liquidity via bond markets and government-backed loan schemes. Raising finance for companies in this category, however, has been more expensive. Finnish airline Finnair, for example, raised a €200 million bond with a 10.25% coupon.

Carnival—the cruise line operator that was an investment-grade credit pre-pandemic before a downgrade to high yield in the summer—provides a further example of this theme. Early in the pandemic, the company priced a US$4 billion high yield bond at 11.5%. A year earlier, it had raised €600 million at a price of 1%, illustrating how swiftly lending markets have shifted in certain sectors. The cruise operator's bond, raised in April 2020, also had to be secured against the company's fleet as collateral.


High-quality credits in demand

Prices have also edged higher for the more resilient borrowers who fall into the third category, but not nearly as much as for credits in harder hit sectors like travel and retail.

Companies in technology and healthcare have been the major beneficiaries, but other credits with strong fundamentals, such as industrials and services, have also been favoured. Loan and high yield markets remain open and eager to support high-quality credits in these select industries.

The €17.2 billion carve-out of ThyssenKrupp's elevators business led by buyout firms Advent and Cinven, along with Germany's RAG Foundation, for example, secured a €10.3 billion package of loan and debt financing in the summer after receiving orders of more than €20 billion from investors.

Despite nervousness from arranging banks about investor uptake following lockdowns, the oversubscribed offer was completed ahead of deadline. Arrangers were able to maintain pricing levels on loans without being flexed, and tighten pricing across all bond tranches. The credit did have to make some concessions on terms, but overall still secured a borrower-friendly document. 

Credit quality and sector resilience are expected to continue colouring lender appetite going into 2021. Lenders will remain selective around the credits they back and willing to provide flexible pricing and terms for the right borrowers. The increasing attention paid to environmental, social and governance factors by CLOs will also see the market favour credits that can address this vital subject. Ongoing money printing and strong anticipated liquidity will build momentum behind these trends.


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


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