The European Leveraged Loans market—like other credit markets—suffered from a sudden and indiscriminate market price decrease at the beginning of the Covid-19 crisis in March, mainly resulting from lack of liquidity across all sub-investment markets and concerns about future rating downgrades and increased probability of defaults.
However, as a result of extensive government support across Europe, prices have staged an impressive recovery, which seems to us somewhat disconnected from the most challenging macro-economic environment that lies ahead.
A handful of companies have seized the opportunity of the relative strength of the market to issue new debt, mainly to extend the maturity of their existing financings. These issues—Loans and Floating Rate Notes—priced wider by 100 to 150 basis points than previous issues and have been well received.
On the other hand, from a macro-perspective, as can be seen in the graph below, the European Leveraged Loan market does not have a short term maturity wall to address while the economy and the market are still in recovery phase.
In this context we maintain a selective and prudent approach to the management of our funds.
Amundi portfolio reactions
During March 2020, Amundi European Leveraged Loans funds have outperformed the market by 1 to 2%. We believe this can be attributed to the broadly diversified nature of the portfolios, a rigorous credit selection process and a focus on more defensive sectors.
While market prices of these loans are likely to fluctuate in the coming months, we have renewed our focus on monitoring each loan’s financial strength and flexibility (liquidity in particular), our position in the capital structure (Senior Secured Debt), the legal operating framework (law and country of the issuer) and our ability to trade the relevant loan. All these efforts are aimed at protecting the invested capital in the medium and long term.
Takeaways from the previous crisis
1) Rise in margins
Based on the assumption that the evolution of the loan market post the GFC of 2008 provides a pertinent framework to inform us, we could anticipate how markets could react after the crisis and when the Leveraged Loans primary market reopens.
Similar to the 2008 to 2010 period, we may expect margins to increase: at this point we would anticipate margins to increase from 350bps to at least 450bps.
2) More protective documentation
Likewise, we may also see tighter loan documentation, possibly with a lower portion of “cov-lite” loans post the Covid-19 crisis. Cov-lite represented more than 90% of transactions in 2019.
3) More conservative structures
We would also expect more conservative capital structures with lower leverage, as was reported post GFC when leverage reduced by almost one turn between 2008 and 2010.
While these changes would be positive to lenders we are still confident the Leveraged Loans market will remain an essential and attractive source of financing for Leveraged Buy-Out transactions due to the stability of the market and the inherent flexibility it brings to capital structures.
European-focused Private Equity asset managers have a record level of capital to invest c. €280 billion as of June 2019 (1). As in previous cycles, we believe Private Equity sponsors will be keen to participate in Mergers and Acquisitions resulting from Corporate restructurings post crisis.
Reminder of Leveraged Loan key characteristics
Leveraged Loans are senior secured debt positioned at the top of the capital structure providing good capital protection for investors.
As such, Leveraged Loans are secured on the borrower’s assets (buildings, intellectual property, patents, brands, shares of subsidiaries, bank accounts).
This “Senior Secured” status in the capital structure is also likely to provide better recovery as the debt has priority claims which are senior to other debt (unsecured debt, second lien, mezzanine) and equity. Over the period from 2000-2017 (including the GFC of 2008), Leveraged Loans exhibited a lower loss rate (aka cost of risk) than High Yield Bonds.
Amundi recently launched the second generation of its successful European bank loans fund. This successor fund is an open ended format, well-structured to allow prudent re-entry into the Leveraged Loans market, taking into account the challenging current macro-economic environment.
(1) Source: Preqin Pro, Preqin Global Private Equity & Venture Capital report, February 2020
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