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

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


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