Credit markets show signs of life after COVID-19 shock

After suffering sharp declines in activity at the start of the second quarter of 2020, loan issuance in North America, Europe and Asia-Pacific (excluding Japan) resumed in June as lockdowns from COVID-19 wore on relaxed.

Despite the stasis that hit the markets in March, April and May, a good start to the year and a recovery in June saw leveraged loan issuance in North America, Europe and Asia-Pacific increase by ‘year on year in the first half of 2020.

Leveraged loan issuance in the United States increased from US $ 404.3 billion in the first half of 2019 to US $ 750.1 billion in the first six months of 2020. In Western and Southern Europe, issuance increased from US $ 110.3 billion to US $ 196.7 billion during the same period. period.

Outside the two largest markets, volumes of leveraged loans in APAC increased from US $ 20.9 billion in the first half of 2019 to US $ 21.7 billion in the second half of 2020, despite a sharp decline in lending activity in the second quarter. However, credit activity in Latin America declined. The volume of syndicated and club loans in G3 currencies ($, € and ¥) in Latin America fell 77% year-on-year to $ 7.8 billion, according to By debt.

A decline in transactions in Latin America lowered the region’s numbers, and corporate borrowers tapped into existing credit facilities rather than taking additional loans. Mexican bakery giant Grupo Bimbo was among the companies to shoot a gun.

Companies strengthen their balance sheets

Borrowers have increasingly turned to loan markets to freeze additional liquidity to overcome uncertainty caused by COVID-19 lockdowns.

The company’s general product amounted to US $ 45 billion in Western and Southern Europe. In North America, US $ 80.2 billion has been allocated for general business use.

At the same time, leveraged loan volumes linked to mergers and acquisitions and buyouts fell across the board, particularly in the second quarter of 2020. For example, leveraged loan issuance in APAC (excluding Japan) recorded a 49% year-on-year decline in mergers and acquisitions and loan volumes, from $ 13.4 billion in the first half of 2019 to $ 6.8 billion in the first half of 2020.

Despite the lack of appetite for M&A financing, some major M&A loans have attracted investor support after the foreclosure. Cornerstone OnDemand launched a US $ 1 billion loan to support its acquisition of Saba Software and technology company Xperi entered the market seeking US $ 1.1 billion to fund its merger with TiVo Corp.

In Europe, the region’s largest buyout ever saw Advent and Cinven raise $ 6.3 billion in loans to fund the $ 18.8 billion acquisition of Thyssenkrupp Elevator. APAC markets were boosted by a US $ 3.6 billion loan issued to finance the US $ 9.6 billion merger between Vodafone Hutchison Australia and TPG Telecom.

Borrowers have also successfully turned to direct lenders to finance mergers and acquisitions. European insurer Ardonagh, for example, secured a £ 1.87 billion (US $ 2.2 billion) unitranche loan led by Ares Management to fund three acquisitions and build cash reserves for future transactions. It is the largest unitranche loan ever issued in Europe.

Push price

Although activity levels and investor loan demand increased in the second quarter of 2020, borrowers had to accept higher costs and more lender-friendly terms to access loan markets in the wake of COVID -19.

In the United States, for example, average margins on senior institutional loans fell from 302 basis points in the first quarter of 2020 to 462 basis points in the second quarter of 2020. more generous original issues (discounts offered by issuers to attract buyers) and stricter documentation conditions. In particular, lenders have focused on limiting the ability of borrowers to move assets out of the credit pool, a tactic many borrowers have used recently.

According to By debt, 52% of loans were issued at 98% or less in the second quarter of the year, an almost total reversal from the trend seen in the first quarter when 52% of transactions were quoted at par or higher. Over 10% of loans were issued at 95% or less in the second quarter.

Similar themes emerged in Europe. Average margins on senior institutional loans fell from 343 basis points in the first quarter of 2020 to 474 basis points in the second quarter. Higher margins and larger issue discounts helped increase average senior institutional loan yields from 3.83% in February to 6.37% in June.

The risk remains

While the green shoots of the recovery seen in loan markets at the end of the second quarter offer a small degree of optimism, the economic fallout from lockdowns and the risk of further outbreaks of COVID-19 pose continuing risks for borrowers. and lenders.

The US and European markets have seen an increase in defaults and credit downgrades in the first six months of the year while in APAC a number of M&A financings remain in limbo.

In the United States, defaults on institutional leveraged loans rose 3.9% in June year-over-year, according to By debt. Defaults for the month totaled US $ 8.2 billion, bringing the cumulative figure for the year to US $ 44 billion. Rating downgrades in the United States were also a feature of the market, with 452 ratings recorded in the second quarter alone.

In Europe, generous government-backed loan programs have helped protect borrowers from defaults. But defaults could increase as government support programs roll out – Fitch Ratings predicts default rates of 4% on European leveraged loans for 2020.

The downgrades of European ratings, meanwhile, have slowed with the reopening of economies, but there have been another 300 downgrades since mid-March, when the lockdowns first took root.

In Asia, the markets are still trying to digest big deals. Freeport Indonesia’s attempts to finance a copper smelter with a US $ 3 billion loan have stalled. The loan was supposed to be syndicated in March, but was frozen after lenders’ commitments expired due to uncertainty surrounding the project.

A HKD 4.5 billion (US $ 581 million) loan to finance a hotel construction project led by Shimao Property Holdings has also been delayed after the COVID-19 disruption slowed the timeline for certification of compliance . Although the loan is now closed, By debt reports that the agreement awaits signature after the borrower asks to change the terms.

Finally, Latin American banks are focusing on managing portfolios during the recession and on their core customer base rather than allocating resources to new activities.

Uncertainty and volatility will continue to weigh on the leveraged loan market in the second half of the year. The risk of default and downgrading remains real and borrowers will have to pay more for their capital to get lender support.

Investors and issuers, however, will be encouraged by the reopening of markets following the lockdowns and will no doubt hope they have gotten through the worst of the COVID-19 disruption.

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