Photographer: Krisztian Bocsi/Bloomberg

Buyouts to Bolster Europe High Yield in 2018 After Stellar Year

  • 96.0 billion euros of bonds sold in primary, the most ever
  • Riskier, triple-C deals set to feature strongly in 2018

M&A activity will likely spur European high yield issuance over the coming 12 months after the market proved its mettle in 2017 -- a year characterized by riskier deals and record breaking volumes, as issuers took advantage of low yields and increased demand for the sector.

The primary market brushed off any shocks this year stemming from a raft of disappointing earnings from high profile and highly leveraged names in the latter part of 2017. With little headline risk on the horizon and the need for yield remaining, market participants expect buyout activity to be aggressively well bid, opening the door to even more triple C issuance and risk-on strategies in 2018.

Read more on how banks are busy lining up M&A mandates in preparation for next year

1. Record Issuance

Since the start of the year non-financial corporates have sold a record breaking 96.0 billion euros-equivalent ($113.2 billion) of high yield bonds in Europe, according to data compiled by Bloomberg. That beats the previous highest total of 76.1 billion euros in 2014, and represents an increase of more than 60 percent on last year’s issuance tally. 

Leveraged buyout activity is expected to take a bigger share of the primary market next year thanks to an insatiable appetite for risk and ultra low funding costs, according to several London based bankers. Market participants won’t have to wait long before they start to see this trend unfold, with candidates for LBO-related bonds in the first quarter including Unilever NV’s spreads business, Akzo Nobel NV and Pure Gym Group Plc.

About three quarters of the 223 issues so far this year have been deals to partly or wholly refinance debt, the data show. That may change next year with sales of high yield bonds predicted to fall from 2017 levels as fewer borrowers carry out opportunistic refinancings, according to an outlook report by Moody’s Investors Services.

Europe’s high yield market "isn’t reacting to anything right now and the first quarter of 2018 will be the same," Armin Peter, global head of European debt syndicate at UBS Ltd. in London, said in an interview. Peter however expects a repositioning for the second half of next year, but only because of a phasing out of the European Central Bank’s asset purchase program.

Landmark deals during the year included:

  • Wind Tre SpA’s three-part euro offering totaling 5.625 billion euros
  • Intrum Justitia AB’s 2.7 billion euro, 3 billion krona four-part bonds
  • Picard Group SAS’ 1.5 billion euro two-tranche transaction
  • Stada Arzneimittel AG’s 1.1 billion euro two-part deal
  • Shop Direct Funding Plc’s 550 million pound issue
  • 2. Record CCC Sales

    Two further records were broken in 2017 in the triple-C space as record low yields provided an opportunity for riskier capital structures to come to the European market. The year saw the biggest amount of issuance, at 7.3 billion euros-equivalent, and the largest ever CCC-rated deal. Last month Verisure Midholding AB priced 1.2 billion euros-equivalent of notes, having asked bondholders to waive previously agreed covenants in order to make a dividend payment.

    It wasn’t all plain sailing however as buyer appetite for some triple C credits waned toward the end of the year. U.S. based BMC Software Finance Inc dropped its planned 380 million euro bond in December with investors citing a highly-levered structure and year-end timing as contributing factors.

    The CCC part of the market is "usually issuers with a story: good companies in a tough market or tough companies in a good market, so it’s very idiosyncratic and there’s lots of variation around individual names," Scott Thiel, deputy chief investment officer of fundamental fixed income at BlackRock International Ltd in London, said in an interview.

    3. Record Low Yields

    In a year when speculative grade yields tightened to the lowest levels on record there was a notable patch of volatility in November. A string of disappointing earnings in the consumer and retail industries, including New Look Secured Issuer Plc and Boparan Finance Plc, drove bond prices sharply and pushed index spreads wider. Steinhoff International Holdings NV has been the most recent casualty from this sector, having seen its rating cut four notches to B1 and its bonds fall by more than 50 cents on the euro.

    Concerns about the U.K. retail industry were evident in the primary market as well. Online fashion retailer Shop Direct was eventually forced to change a clause in its shareholder distribution basket, reducing it to 50 million pounds from 200 million pounds, after meeting resistance from investors. The issuer also ditched plans for a floating rate tranche.

    Elsewhere, Altice NV lost almost 60 percent of its market capitalization in November after the global telecom provider cut its profit outlook. The move forced investors to question whether the company’s assets can support its highly-levered structure. Single B-rated bonds from Altice and its subsidiary SFR Group SA suffered materially more than the other high-yield rating buckets during last month’s period of volatility.

    That all said, the recent wobbles in the market “won’t put issuers off new issues next year as rates are incredibly low by historical standards," according to BlackRock’s Thiel.

    4. Record Loan Volume

    While euro-denominated high yield bonds have returned 6.8 percent in 2017, that may be difficult to match over the coming year owing to "a pullback from current valuations," according to JPMorgan.

    European high yield spread could widen 50 basis points next year to deliver a total return of 1 percent, JPMorgan strategist Daniel Lamy wrote in a research note. "We think loan prices will remain relatively stable during 2018 and that the asset class will see another coupon year, which equates to a 3.5 percent return," Lamy said.

    That view was echoed by Azhar Hussain, head of high-yield and leveraged loans at Royal London Asset Management. "Overall we’ll favour loans over bonds in 2018. We’re optimistic on loans for next year," Hussain said. "We think they will generate more returns and we generally feel like the sector will hold lower risks and default rates versus bonds."

    Read more on why institutional loan issuance in 2017 is highest since the financial crisis

    Deutsche Bank is forecasting a negative total return of 0.3 percent for European high yield in 2018. Analysts at the German lender also expect leveraged loans to outperform bonds, citing pressure on high yield spreads in the second quarter of the coming year.

    Loans "benefit from past market dynamics as well as extra carry," credit strategist Jim Reid wrote in a research note.

    — With assistance by Charles Daly

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