The European high-yield market continues to defy superlatives in 2021, and with conditions about as good as they can get, it is now well on track for a record-breaking year.
Indeed, after a blistering six months it is hard to find fault with the market's performance. High-yield volume in the second quarter of 2021 reached €38.3 billion to take the first-half tally to €76.6 billion. This is already through the €63.5 billion recorded in full-year 2018 and €74.1 billion notched up in 2019, and is also now closing in on the full-year volume of €85 billion seen in 2020. It also puts the market on course to exceed 2017's record €93.7 billion issuance volume for a full year. "This is what all the monetary accommodation was meant to achieve, which was to un-gum the market and get financing flowing through the economy," said one banker.
Pricing too remained stable, with the average yield through the second quarter rising marginally for single-B names to 4.68% and widening slightly to 2.80% for double-B credits. This doesn't quite tell the full story, however. "Banks often start with eye-catching [initial price talks] then come with price talk of a quarter-point inside this," said one investor. LCD data bears this out to show that the vast majority of deals in the second quarter priced at either the tight end of or tighter than guidance, with just one bond pricing wide of guidance so far this year.
That deal was the secured portion of the bond and loan refinancing for German beauty retailer Douglas Holding AG, which eventually priced at 6%. Douglas' financing, however, underlined the demand for the so-called reopening trade, or those deals from pandemic-exposed borrowers now benefiting from the ending of lockdowns. A steady stream of credits have followed over the past three months, and these borrowers have tended to focus on high-yield rather than loans, given the benefit investors receive from call protection. "Being defensive has not been the trade to play this year," said one investor.
Rather, the focus has been on providing liquidity, and the quarter saw pandemic-exposed borrowers such as Punch, NH Hotel Group SA, David Lloyd Leisure Ltd. and Golden Goose SpA all come to market and put in place long-term financing packages. These borrowers were also able to take advantage of a generally strong first-quarter reporting season that provided further evidence of the strength coming from reopening, with few signs of inflation creeping into the supply chain. "The second quarter will not have such an easy like-for-like comparable to follow," noted one manager. Meanwhile, the €480 million financing from Italian trainer-maker Golden Goose cleared the last of the pre-pandemic bridges and took out a loan supporting Permira's buyout of the firm.
These deals, and others, helped boost the high-yield refinancing volume, which rose to the highest quarterly total since the end of 2019, at €15.1 billion. Beyond the refinancings, the market is moving away from the defensive and toward the offensive, as M&A-related volume in bonds surged to a quarterly record high of €12.7 billion. This spike came as sponsors returned to the buyout trail to take advantage of the post-pandemic uplift to put their dry powder to work. "Private equity was internally focused for the first six-to-nine months of the pandemic on the balance sheets of their portfolio companies," said one manager. "Now that work is done, they are expanding aggressively again," he added, while also pointing out there is roughly $2 trillion of dry powder ready for deployment globally.
Here, bonds have benefited not only from a flurry of Italian deals — which, because of withholding tax issues, tend to go to the bond rather than loan markets — but also a steady flow of cross-product buyout deals. These now regularly feature sponsors using high yield not just to layer-in unsecured debt, but to place secured debt alongside a term loan. This both provides an anchor for the unsecured portion of the capital structure but also generates pricing tension between the secured tranches. Others are using this tension and adding bonds into all-first-lien structures, such as the debt financing supporting Carlyle-backed Nouryon's spinoff of industrial chemicals group Nobian.
This deal was split between a €525 million offer of sustainability-linked secured notes priced at 3.625% and a €1.09 billion term loan at E+375 with a 0% floor offered at 99.5, and shows that there is more than enough demand in bonds to drive pricing below loans. That yield differential, bankers note, tends to be wiped out when taking note of the swap rate, and other pari-passu deals such as PaySafe have seen the bonds and loans price on top of each other. As such, most bankers agree pricing is rarely the primary reason when it comes to choosing one product over another. "Pricing is part of the ebb and flow of the market and it's up to borrowers to balance their desire for yield and call flexibility," said one banker.
Either way, these deals have helped drive the share of the market taken by single-B names to the highest proportion ever. In the second quarter alone, single-B rated transactions accounted for 49 of all 84 deals. This is not the type of proportion most would think about when considering European high yield, which tends to be seen as more of a double-B market, with loans as the primary single-B carrier. That said, sources note that the bond investor base in Europe has shifted through the year, with investment-grade funds, CLOs and other strategies now playing a greater role. "The participation in our market by traditional high-yield funds is at a historic low," said one manager at a global firm.
The continued presence of investment-grade buyers dipping down, for example, helps to keep yields for double-B and other good-quality names tight. "These buyers are having to deal with sub-1% investment-grade yields so anything over 2% looks good," the same manager notes. In late June, for example, Polish e-commerce enablement group InPost SA priced a Ba2/BB rated €490 million offering of senior notes at 2.250%, in from IPTs of high-2% and price talk of 2.500% that was revised to 2.375% area.
Can the party last?
The question is then, can this super-strong market tone last? The backdrop through the second quarter has remained calm, with the market brushing off any volatility that followed a more hawkish than expected outcome from the June Federal Open Market Committee meeting, while the iTraxx Crossover has generally tightened through the period. That said, the threat of inflation is now a more popular topic of conversation, even if most agree the effects are more likely to be transitory rather than structural. "I don't really understand the idea that we're about to break into a new world of 1970s-style inflation," said one manager. Another manager concurred: "We are definitely seeing inflationary pressures in some sectors, whether that is in the supply chain or labor costs," he said. "But this is to be expected as the economy adjusts to the new normal after COVID-19, and so will most likely be temporary."
The threat from rising rates is perhaps more pertinent, even if bankers argue that high yield is primarily a credit market and should therefore be more immune than investment-grade to such pressure. Even so, there is a read-through in the market's appetite for duration, and LCD data shows a slight shift away from tenors of more than seven years through the first quarter. Investors are willing to look at longer-term deals though, and U.K. telco VMED O2 UK Ltd. wrapped a 10-year offering of dual-currency notes in June that included a £675 million tranche. That tranche did, however, price at the widest end of 4.375%-4.500% price talk (though this was in line with IPTs of mid-4%).
These concerns are not likely to disrupt the party just yet, and the market looks on course for a busy run as the summer progresses. The last full week of the second quarter, for example, brought the largest weekly high-yield issuance count since July 2020, with 11 deals printing for a total of €5.05 billion, and minimal signs of market indigestion. This supply exceeded most accounts' expectations, leading to speculation that borrowers are opting to bring their plans forward rather than wait for the fall, when the issuing environment may not be so benign.
"We always recommend issuers come now rather than wait," admitted one banker at a leading arranger firm. "But there is a realization that these conditions will not last forever, so there is a clear rationale for borrowers to issue now if they can."