Europe’s Junk Bonanza Helps LBO Firms Cut Loans: Credit MarketsPatricia Kuo
European junk-bond sales are off to the busiest start on record as companies owned by private-equity firms such as Permira Advisers LLP and Doughty Hanson & Co. take advantage of plummeting yields to repay loans.
The region’s neediest borrowers have issued $17 billion of speculative-grade bonds this month, according to data compiled by Bloomberg. That’s 38 percent more than the previous high of $12.3 billion in January 2011. Odigeo Group, an online travel company co-owned by Permira, repaid 315 million euros ($427.3 million) of loans by selling notes, the data show.
Investors are snapping up European junk bonds as the region’s debt crisis subsides and central banks globally keep interest rates at unprecedented lows, helping speculative-grade borrowers tackle the more than $352 billion of loans due from 2014 as banks pare lending, Fitch Ratings said. Demand for junk bonds also may trigger a rebound in European leveraged buyouts, which fell more than 30 percent last quarter to $15.7 billion.
“PE firms’ switch to high-yield bonds from loans is a reaction to the relative attractiveness of debt instruments in today’s market,” Max Biagosch, the London-based head of Permira’s financing group wrote in an e-mail. Borrowers are also looking to alternative funding sources because bank loans are likely to decrease in the next few years, he said.
European lenders are selling assets and reducing lending, needing to more than triple the core capital they hold under new standards from the Basel Committee on Banking Supervision. Companies in the region owned by buyout firms raised $70.9 billion of loans last year, less than the $73.7 billion in 2011, Bloomberg data show. That’s the fifth straight year that the amount of such loans decreased.
“The deleveraging of the European banking system is the fundamental factor raising doubt over the ability of many legacy leveraged borrowers to meet their refinancing requirements,” Edward Eyerman, head of Fitch’s London-based European leveraged finance team, wrote in a December report.
Elsewhere in credit markets, a gauge of U.S. corporate credit risk declined. The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, fell 1.2 basis point to a mid-price of 88.1 basis points at 11:35 a.m. in New York, according to prices compiled by Bloomberg. The measure rose to 90.3 yesterday, the highest level since Dec. 31.
The measure typically rises as investor confidence deteriorates and falls as it improves. The contracts pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
The U.S. two-year interest-rate swap spread, a measure of debt-market stress, increased 0.84 basis point to 16.75 basis points as of 11:36 a.m. in New York. The gauge widens when investors seek the perceived safety of government securities and narrows when the favor assets such as company debt.
The market for corporate borrowing through U.S. commercial paper contracted for a second week after three months of increases.
The seasonally adjusted amount of U.S. commercial paper decreased about $700 million to $1.125 trillion outstanding in the week ended yesterday, the Federal Reserve said today on its website. That’s the lowest level since the market touched $1.105 trillion in the period ended Jan. 9.
Junk-rated borrowers in Europe also face a shrinking market for collateralized loan obligations. Only two new CLOs have been issued in the last four years, down from a 2007 peak of 35 billion euros, Bloomberg and Fitch data show.
Existing CLOs will also see their role reduced with JPMorgan estimating that $53 billion of the funds will exit their reinvestment periods in the next two years. This means the funds must start using interest payments received on loans they hold to pay off investors rather than buy debt.
CLOs pool high-yield, high-risk loans and slice them into securities of various risk and return. The funds account for the largest group of non-bank buyers of the debt in the region, according to JPMorgan.
Junk bonds in Europe have been rallying as confidence in the region’s ability to tame its debt crisis increases. European Central Bank President Mario Draghi said in July that the bank will do what it takes to preserve the euro, sparking a jump in speculative-grade bonds that reduced their yields to a record of 5.3 percent on Jan. 11, Bank of America Merrill Lynch data show. The debt yielded 9.6 percent at the start of 2012.
Leveraged loans and high-yield, high-risk bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- at Standard & Poor’s.
For companies owned by buyout firms, the average interest paid above benchmark rates for loans has increased to 475 basis points in 2012 from 422 basis points in 2011, Bloomberg data show. With loans remaining relatively more costly than notes, more borrowers may turn to the bond market for financing.
“We expect a large amount of leveraged corporates to become bond issuers in 2013, making Europe more like the U.S. market,” said Henrik Johnsson, head of European High Yield Capital Markets at Deutsche Bank AG in London. “The bullish sentiment on mid-term European growth and low financing costs will allow more M&A activity. We are currently working on a record number of large LBO transactions.”
CVC Capital Partners Ltd., a private equity firm, raised 780 million euros of high-yield bonds earlier this month to back its buyout of Cerved Group SpA, an Italian business credit information provider.
Odigeo, owned by Axa Private Equity and Permira Advisers LLP, sold 325 million euros of 7.5 percent notes on Jan. 23 to repay 315 million euros of term loans, according to bond documents obtained by Bloomberg.
Doughty Hanson, the London-based buyout firm, has tapped the junk-bond market three times since November to refinance the loans of its companies, Bloomberg data show. In the latest debt sale, Zobele Holding SpA, an air care and insecticide devices supplier which counts Procter & Gamble Co. as its client, issued 180 million euros of 7.875 percent bonds on Jan. 24 to repay 166 million euros of loans.
“The driver behind sponsors switching into bonds is the strength of the demand, with market appetite for high-quality paper, both fixed and floating rate,” Nick Bastin, a London-based spokesman for Doughty Hanson, said in an e-mailed statement.
Using high-yield bonds to repay loans may provide private-equity firms with more time to reduce debt at companies they own and turnaround their businesses while equity financing remains weak. Initial public offerings in 2012 raised $112 billion globally, the least since 2008, Bloomberg data show.
“Ideally, LBOs created equity value both by growing the company and by debt reduction from free cash flow,” said Peter Aspbury, a high-yield investor at JPMorgan Asset Management, which oversees $1.4 trillion. “High-yield bond refinancings often highlight the inability of the company to pay down debt or of the sponsor to achieve a profitable exit. If the sponsors can’t create equity value, then the risk of future impairment for creditors grows.”