Editor’s Note: This article has been revised and updated since the original version was published on July 24. White & Case’s third-party data provider alerted us that certain of the data they had provided, which formed the basis of the original article, was incorrect. The article below reflects the updated data provided to White & Case, and relevant revisions to reflect the same.
After suffering steep declines in activity early in Q2 2020, loan issuance in North America and Europe revived in June as COVID-19 lockdowns eased.
Despite the drop in activity in March, April and May, a strong start to the year and a June recovery saw leveraged loan issuance in North America and Europe increase year on year in H1 2020.
Leveraged loan issuance in the United States was up from US$404.3 billion in the first half of 2019 to US$451.5 billion for the first six months of 2020. In Western and Southern Europe, issuance climbed from US$110.3 billion to US$139.3 billion in the same period.
Outside the two largest markets, leveraged loan volumes in APAC dropped from US$20.9 billion in H1 2019 to US$15.7 billion in H1 2020—though deals held steady at US$7.8 billion in Q1 and US$7.9 billion in Q2. Loan activity in Latin America was also down. Volume for syndicated and club loans in G3 currencies ($, € and ¥) in Latin America fell 77% year on year to US$7.8 billion, according to Debtwire Par.
A drop in Latin American deal activity dragged numbers for the region down and corporate borrowers have drawn on existing credit facilities rather than take on additional borrowings. Mexican bakery giant Grupo Bimbo was among the companies to draw on a revolver.
Companies shore up balance sheets
Borrowers increasingly turned to loan markets to lock in additional liquidity to navigate uncertainty caused by COVID-19 lockdowns.
In H1 2020, general corporate proceeds accounted for US$42.7 billion in Western and Southern Europe. In North America, US$61 billion was allocated to general corporate use during the same period.
M&A and buyout-related leveraged loan volumes, meanwhile, dropped across the board, especially in Q2 2020. For example, leveraged loan issuance in APAC (excluding Japan) saw a year-on-year fall in M&A and buyout-related leveraged loan values, from US$13.4 billion in H1 2019 to US$4.4 billion in H1 2020.
Despite the lack of appetite for M&A financing, some sizeable M&A credits attracted investor backing post lockdown. Cornerstone OnDemand launched a US$1 billion loan to support its acquisition of Saba Software and technology company Xperi came to market seeking US$1.1 billion to fund its merger with TiVo Corp.
In Europe, the largest-ever buyout in the region saw Advent and Cinven raise US$6.3 billion worth of loans to finance the US$18.8 billion acquisition of Thyssenkrupp Elevator. APAC markets were lifted by a US$3.6 billion loan issued to fund the US$9.6 billion merger between Vodafone Hutchison Australia and TPG Telecom.
Borrowers also successfully turned to direct lenders to fund M&A. 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 up cash reserves for future deals. The facility is the largest-ever unitranche loan issued in Europe.
Pricing push
Although activity levels and investor demand for loans picked up during Q2 2020, borrowers had to accept higher costs and more lender-friendly terms to access loan markets following COVID-19.
In the US, for example, the average margins on first lien institutional loans climbed from 302 basis points in Q1 2020 to 462 basis points in Q2 2020. US issuers have also had to offer more generous original issue discounts (discounts offered by issuers to attract buyers) and tighter documentation terms. In particular, lenders have focused on limiting borrowers’ ability to move assets outside of the credit group—a tactic many borrowers have used recently.
According to Debtwire Par, 52% of loans were issued at 98% or lower in the second quarter of the year, an almost total reversal on the trend observed in Q1 when 52% of deals priced at par or higher. More than 10% of loans were issued at 95% or lower in the second quarter.
Similar themes have emerged in Europe. Average margins on first lien institutional loans climbed from 343 basis points in Q1 2020 to 474 basis points in Q2. Higher margins and larger original issue discounts have contributed to the rise in the average yields of first lien institutional loans from 3.83% in February to 6.37% in June.
Risk remains
Although the green shoots of recovery observed across loan markets late in Q2 provide a small degree of optimism, the economic fallout from lockdowns and the possibility of further COVID-19 flare-ups pose ongoing risks for borrowers and lenders.
US and European markets have seen increases in defaults and ratings downgrades in the first six months of the year while, in APAC, a number of M&A deal financings remain in limbo.
Institutional leveraged loan defaults in the US climbed 3.9% in June on a trailing 12-month basis, according to Debtwire Par. Defaults for the month totaled US$8.2 billion, taking the year-to-date figure to US$44 billion. Ratings downgrades in the US have been a feature of the market as well, with 452 recorded in Q2 alone.
In Europe, generous government-backed loan schemes have helped to shield borrowers from defaults. But defaults could move higher as government support schemes unwind—Fitch Ratings forecasts default rates for European leveraged loans of 4% for 2020.
European ratings downgrades, meanwhile, have slowed as economies have reopened, but there have still been 300 downgrades since mid-March when lockdowns first took hold.
In Asia, markets are still trying to digest large deals. Freeport Indonesia’s attempts to fund a copper smelter with a US$3 billion loan have stalled. The loan was scheduled to go into syndication in March but has been put on ice after lender commitments expired due to uncertainty around the project.
An HKD 4.5 billion (US$581 million) loan to fund a hotel construction project led by Shimao Property Holdings was also delayed after COVID-19 disruption slowed the compliance-certification timeline. Although the loan has now closed, Debtwire Par reports that the deal awaits signing after borrower requests to change terms.
Finally, banks in Latin America are focusing on stewarding portfolios through the downturn and their core client base rather than directing resources into new activity.
Uncertainty and volatility will continue to weigh on the leveraged loan market in the second half of the year. The risk of defaults and ratings downgrades remains real, and borrowers will have to pay more for their capital to secure lender support.
Investors and issuers, however, will be encouraged by the reopening of markets following the lockdowns and no doubt hope they have navigated the worst of the COVID-19 disruption.
