Risky Business Set to Dominate High-Yield Bond Market in 2018

  • LBO, single B deals expected to feature in bigger way: bankers
  • U.S borrowers likely to continue to use Europe for debt sales

If 2017 is judged to be the year of big but boring refinancings for the European high-yield market, next year is shaping up to be a different proposition with leveraged buyouts and lower-rated credits expected to drive a bigger share of bond sales.

Yield-hungry investors have embraced the glut of supply in Europe so far this year, helping borrowers secure ultra-low funding costs and negotiate favorable terms on their bond transactions. This has been fueling issuers’ appetite, and may open the door to more LBO-driven activity, as well as supply from "riskier" credits in 2018, bankers have said.

"While in the first six months of this year people were hesitant, we are now starting to see risk appetite increasing with borrowers more confident to take advantage of the market conditions," said Tanneguy de Carne, global head of high-yield capital markets at Societe Generale in London. "We’re telling sponsors and companies that now is the time to think about their financing plans."

De Carne says this message is now also being directed at triple C plus issuers, "something we couldn’t say so clearly" in the first part of this year. "We’re also sensing that investors are a lot more willing to consider and invest in more aggressive deals, difficult credit and turnaround stories," he said. Double B-rated companies and refinancings continue to represent the bulk of issuance in the high-yield market this year.

Europe’s high-yield market has been on a tear in 2017 with 73 billion euros-equivalent of issuance, helped by jumbo financings from borrowers including Stada Arzneimittel AG and Softbank Group Corp, as well as Wind Tre SpA that’s expected to price this week. Sales may hit as much as 75 billion euros, according to Diarmuid Toomey, head of European high yield capital markets at Deutsche Bank, making it the busiest year on record.

Fight for Yield

High-yield investors facing ongoing pressure to depose cash have been forced to accept lower yields and loser covenants this year. The average yield on The Bloomberg Barclays Euro High Yield index fell to a record low of 2.86 percent on Friday.

Stada’s 735 million-euro bond sale in September was an example of this new dynamic, with the deal being upsized on the back of a strong order book despite investors’ attempt to push back on a covenant clause. Overall covenant quality has been declining, with more than 37 percent of high-yield euro bonds classified as weak or weakest in the first half of this year, up from around 12 percent in 2012, according to Moody’s.

"Investors are giving up the upside to many deals slowly as there is a greater need to put money to work," said Azhar Hussain, head of high-yield and leveraged loans team at Royal London Asset Management. "We’re mainly focused on the credit story rather than the terms and covenants, and on that basis we are cherry picking. But in many cases investors who can’t do this are being forced to buy almost everything right now."

Crossing the Pond

Banks are also anticipating more U.S. companies to tap the European market in a bid to diversify funding and capitalize on the region’s low interest rates in light of ongoing U.S. rate hikes.

"U.S.-based issuers with a desire for euro- or sterling-denominated debt liabilities are increasingly interested in issuing directly in euros or sterling given the relatively low interest rate and tight spread environment that continues to prevail in Europe," said Mathias Blumschein, co-head of high-yield debt capital markets at ING Groep NV. The economics of issuing in dollars and swapping back into euros have become less attractive, he said.

Bond sales from Diversey Inc, Aramark and Netflix Inc have helped take year-to-date European issuance of high-yield bonds by U.S. firms to a record 11.0 billion euros-equivalent, according to data compiled by Bloomberg. This has already eclipsed the previous highest full-year total of 9.7 billion euros-equivalent in 2016, the data show.

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