The amount of liquidity in the market is unprecedented for a crisis such as the one economies are currently facing amid the COVID-19 pandemic, and is keeping a lid on major distressed situations — at least for now, as restructuring activity and defaults remain below historic peaks.

This market liquidity has also continued to send secondary loan prices higher over the last two months, despite lockdown restrictions across Europe still being firmly in place until at least mid-February, thereby hampering business activity, and there being no certainty as to when restrictions will be lifted.

Even names in sectors heavily impacted by the pandemic continue to rise in secondary markets as investors reach for yield, and amid concerns they could miss the train to recovery. Cruise-line operator Hurtigruten ASA is a case in point here. The borrower's term loan B is bid around 88 this month, having risen steadily since November 2020 when it was bid at 73. Elsewhere, B&B Hotels is up at 93-bid, from 84 in November, while travel-catering firm Areas Worldwide SA pulled above 91-bid this week, having been at 88.25 in early January.

The primary market too is awash with cash, allowing high-yield and leveraged loan borrowers to tap funding at cheap rates, despite falling revenues due to COVID-19. As one buyside account said this week: “Some companies are worse off than a year ago, and they are borrowing money at cheaper rates than ever."

"It feels like we are back to pre-crisis levels almost, and the default rate has not really spiked, even though everyone knows Q1 is a write-off in terms of normal business activity,” said another buyside manager this week. "Some companies, especially in the leisure and retail sectors, just see their leverage multiples rising and rising, but as long as they have liquidity, no one seems to care. You would think that sooner or later this could catch up with us."

Default driver
Restructuring advisers agree that unlike in past crises, liquidity will be the main driver of defaults. But there is indeed a risk that the current accumulation of debt due to cheap rates could come back and bite both borrowers and investors. “High-yield sometimes used to be 10%-plus, but with non-investment-grade spreads as low as they are, pressure from interest payments is not what it once was. However, following the COVID-19 recession, liquidity shortfalls stemming from businesses ramping up to pre-crisis levels of activity will be a major driver of default rates going forward,” said Joseph Swanson, co-head of Houlihan Lokey's EMEA Restructuring Group.

This is not to say that there are no restructurings taking place, but many of those situations currently in the market have faced problems before this crisis, and the rush of pandemic-related restructurings has yet to emerge. The default rate for December 2020 on the S&P European Leveraged Loan Index (ELLI) based on principal amount outstanding was 2.57%, just below the monthly high of 2.61% in October 2020. In December 2009, this rate stood at 10.54%.