After rebounding from COVID lows, transaction volume is likely to remain elevated going forward; investors may need to be careful in assessing related risks.

As the pandemic took hold in March 2020, we expected elevated uncertainties in the operating environment to have a chilling effect on mergers and acquisitions. Looking back now, the drop-off is unmistakable, from around $800 billion in transaction value in North America in the first half of 2019 to around $200 billion in the first half of 2020. With the intervention of the Federal Reserve stabilizing financial conditions, M&A activity rebounded in the second half to over $700 million, above second half levels in each of the prior five years.

A closer look confirms the rebound was driven by high-quality issuers, particularly in COVID-resilient sectors like Technology, Consumer, Health Care, Telecom and Cable/Media. Spared the heightened disruptions in some COVID-sensitive sectors, these issuers were able to lean on deals to execute against long-term goals. Relative to recent history, issuers across the investment-grade quality spectrum were generally more conservative in financing deals in 2020. Importantly, BBB issuers continued to be more conservative than higher-rated companies.

For 2021, we expect M&A activity to remain elevated. As a foundation, the ongoing rollout of COVID vaccines is expected to drive recovery and a constructive growth backdrop. In addition, financing conditions remain attractive. Beyond that, IG companies have record levels of cash to put to work and we expect M&A to be a key capital allocation priority for many companies looking to capitalize on opportunities in the post-COVID operating environment. We saw evidence of this during the recent bank earnings season as management commentaries highlighted healthy deal pipelines.

Specifically, we expect single-A Industrials with underlying businesses that benefitted from COVID to be more willing to lever up to fund strategic acquisitions. We expect BBBs to be more credit-friendly in aggregate —remaining in deleveraging mode or using equity to ease the credit impact of deal financing. From a sector perspective, we anticipate increased deal activity in the Technology, Cable/Media, Consumer/Retail, Health Care, Energy and Financial sectors, with valuations likely to be constraining but not prohibitive.

Given this backdrop, we expect to exercise increased scrutiny around acquisition merits, deal valuations and management. We are increasingly thinking about potential regulatory and policy risks around deal activity. While we anticipate increased idiosyncratic risks in 2021, we do not expect this to be enough to derail our expectation for modest spread tightening over the course of the year.