The effects from COVID-19 may be in the rearview mirror for some industries and the broader markets, but we see a bumpy road ahead for certain sectors/companies as they struggle with increased debt obligations on already over-levered balance sheets.
Over the course of 2020, central bank accommodation and intervention allowed capital markets to stabilize. Gross loan and high yield new issuance grew $800 billion year-over-year in 2020, not including existing facility draws and private debt placements. As companies continued to access liquidity, some incurred additional permanent debt on capital structures that were already stressed entering the pandemic. While the liquidity infusion has allowed many companies to avoid near-term default, the increased leverage and limited covenant triggers will likely produce “zombie” credits in those companies that were over-levered entering the pandemic. These companies, burdened with unsustainable capital structures, will require restructurings and debt exchanges with overall company valuation breaking deep within the debt stack. We believe this will cause meaningful debt price declines as investors reassess the risk/reward dynamics due to heightened credit worthiness and debt recovery concerns.
Absent any broader capital markets disruption, we currently see an array of opportunities that are more idiosyncratic and episodic in industries directly affected by the pandemic, including but not limited to Commercial Real Estate, Lodging & Leisure, Aerospace & Defense, Retail and Transportation. Companies and assets in these industries are struggling to manage their business operations and inject needed investment expenditures due to the higher debt burden incurred in 2020. We are also seeing opportunities for rescue financings and supply chain funding requests across many of these dislocated industries.
Investors should remain opportunistic and disciplined given the broad array of opportunities in the distressed/special situations universe and the divergent outcomes in a recovery. We believe investors should seek out investments in the more senior and secured parts of the capital structure, as loss severity in times of distress is borne by more subordinated creditors. Finally, investors should remain focused on companies and specific assets with competitive market positions, which provide a product or service with industry relevance, and are poised for strong operating performance as the threat from COVID-19 recedes and overall economic conditions rebound.