Single Bs dominate European high-yield volume as LBO bottleneck bursts

There was a sea change in the European high-yield bond space in October, both in terms of the types of deals coming through and the development of the most challenging backdrop for new issues since the market reopened from the initial COVID-19 pandemic hit in the first half of 2020. Issuance volume has held up — with October notching up the second-heaviest monthly supply tally this year — but the deluge of paper took its toll, compromising price discovery in bookbuilding and forcing issuers to pay larger concessions due to a consistently weak secondary market.

As October's volume indicates, conditions are still attractive, but they are more investor-friendly than in the first three quarters of the year. "I would say the backdrop is constructive," says a syndicate head at a European bank. "Rates have moved, the pricing environment has normalised, and investors are reacting to that normalisation by taking more time to do the credit work, and deciding what they want and at what price. The price they get and any new-issue premium are very much in focus, and that is the reason you are not seeing massive moves on pricing from initial price thoughts to launch."

The key data point is a shift to LBOs and M&A financing in recent weeks, which characterizes the third stage of European high yield's response to the pandemic. Initially, euro-focused high-yield borrowers were slow to issue bonds compared with their U.S. and investment-grade-rated peers, instead relying on their banking relationships, and in many cases state support, to weather the early stages of the pandemic. Tightening credit spreads then ushered in a huge wave of refinancing, which began in June 2020 and dominated volumes until September this year.

October, however, saw a sudden (albeit well-telegraphed) shift to a bond market dominated by M&A and LBO financing. Much of the supply had been pencilled in for September, banks said at the time, but several large deals did not appear until October, after deal preparation took longer than expected. Although last week saw a pickup in opportunistic refinancing transactions for borrowers such as Teva Pharmaceutical Industries Ltd., Rexel and Lufthansa, imminent deals for buyouts of Morrisons and T-Mobile Netherlands mean that M&A bonds are likely to lead the pack again in November.

Some transaction-related deals were perceived to be aggressively priced by investors and have contributed to the trend of deals such as Iliad Holding SAS coming wider than price guidance or underperforming on the break, as with MásMóvil Ibercom SA. Deals including Iliad, Modulaire Investments BV and Multiversity also featured an overhaul of bond documentation following investor pushback.

Bankers do not expect the trend to last, however, and say the recent dominance of LBOs is better understood as a reflection of the hiatus in deal-making during the pandemic. "Compared to where banks were sitting in the summer from a risk perspective, the amount of risk on underwriters is greatly reduced," notes one banker. "I wonder what that means for volumes at the start of next year — it could be underwhelming from an LBO perspective, particularly on the European side."

Pandemic shift to single Bs

One of the most obvious effects of the deluge of sponsor-backed transactions is that new issues are overwhelmingly in the single-B category. Double-B-rated issuers sold €11.23 billion of high-yield bonds into the European market in October, according to LCD data, which is the largest such monthly total this year; that takes annual supply in this ratings bracket to €55.56 billion through October and accounts for roughly half of the total annual supply. By comparison, issuance by single-B-rated credits accounted for just 38% of total supply in 2020, and 33% in 2019.

Historically, these credits have favoured leveraged loans, with the high-yield bond market traditionally dominated by double-B-rated corporates. The question is, has the post-pandemic bond rally persuaded sponsors to favor high-yield bonds instead of loans? After all, the bond market was the driving force behind pandemic recovery as the asset class to most immediately feel the effect of coordinated central bank stimulus. What is more, high-yield bonds are hard for sponsors to overlook from a pricing perspective. As LCD data shows, average new-issue yields for the single-B-ratings bracket have stayed below 5% throughout 2021 and from the second quarter of 2019 to the first quarter of 2020, only climbing above this handle for the final three quarters of 2020.

Sponsors still prefer loans

That said, the answer to the asset-class question posed above is "probably not," according to bankers. "The balance of loans versus bonds is a function of the strength of the loan market at any given time," says the head of one leveraged finance department involved in big-ticket LBOs. "Ultimately, we are still seeing sponsors migrate to loans where they can."

LCD data, which shows year-to-date European leveraged loan issuance already exceeding all years on record other than 2007, indicates a market in fine health. For recent LBOs from borrowers such as Modulaire and Aggreko PLC, the bond portions were only slightly larger than the loans. The funding package backing the buyout of T-Mobile Netherlands by Apax Partners and Warburg Pincus shows a preference toward loans, with a €2 billion term loan B set to be accompanied by €800 million in secured bonds and €550 million in unsecured notes.

But there are other explanations for the recent bias toward bonds over leveraged loans, even if sponsors ultimately prefer the latter. "If you look at single-B issuance, for sterling bonds or names with existing bonds, bonds are a heavy feature of new supply," comments another senior leveraged finance banker. This was the case for Burger King France SAS, which sold €855 million of secured floating-rate and PIK notes to take out existing bonds.

Sterling effort

Issuance in sterling is a further driver of this trend, with six deals printed in the currency in October — five of which were sponsor-backed, and five of which were in the single-B-ratings bracket. RAC Bidco Ltd (B+) sold £345 million of notes to fund a dividend to its new majority owner, Silver Lake, while Arrow Global Group PLC (B+/B1/BB-) and Modulaire (B/B2/B+) sold secured sterling notes alongside euro tranches backing their leveraged buyouts.

In euros, another contributor to the recent bond bias has been the record number of Italian names issuing this year. Due to Italian withholding tax law, issuers are often forced to choose bonds over loans. According to LCD data, Italian high-yield companies have raised €16.2 billion so far this year, surpassing the previous record of €13.9 billion set in 2017 when telecom operator Wind Tre sold a €7.3 billion-equivalent cross-border deal (which at the time marked the largest issuance of euro-denominated bonds by a single borrower in one go).

By contrast, this year has hosted a far greater number of Italian issuers, with 31 tranches in total across euros and dollars, which is typical of a market dominated by LBOs and new names. Of the six issuers that appeared in October — including buyout financings for BIP, Arcaplanet, Polynt, EOLO and Multiversity — only IT services provider Almaviva was a repeat issuer, raising €350 million of five-year notes to refinance expensive bonds maturing in 2022.