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Leveraged loan market suggests Brexit little impediment to UK deals

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Leveraged loan market suggests Brexit little impediment to UK deals

The European leveraged loan market’s forward calendar for the rest of the year is dominated by transactions from U.K.-domiciled issuers, suggesting there will be a surge in British deals even as political chaos in the country looks set to reach its climax.

In total, €7.83 billion of the European market’s pipeline of deals comes from U.K. firms — including the debt backing the £5.9 billion take-private of Merlin Entertainments PLC by a consortium of Blackstone Advisory Partners LP, KIRKBI A/S, and CPPIB Capital Inc., and that funding Advent Advisors Inc.’s £4 billion acquisition of U.K. defence and aerospace group Cobham PLC. Following an intervention from the government, the Cobham deal is now being investigated by the U.K. Competition and Markets Authority, with a report to be prepared by Oct. 29.

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The timing of this U.K. issuance over the next couple of months may be worrying for some, given this period will likely see the culmination of the parliamentary wrangle over Brexit, and also includes the current withdrawal date of Oct. 31. However, given the withdrawal date has already been moved before — and may yet be moved again — market participants say this concurrence of U.K.-based leveraged supply and climax of the political debate is purely coincidental, and point out there has not been a period in more than three years during which the market has been free from expected Brexit deadlines or crises.

"Since the referendum, there have been pockets of expectation that Brexit would happen on a certain day, or that an election was due," says a banker. "If you’d tried to mitigate around that, it would have been impossible. If you sat on your hands and waited for after Oct. 31 then you’d never get deals done. You can’t second guess the political calendar at the moment — it’s a mug’s game."

Geographical diversity

Moreover, many U.K.-domiciled issuers hitting the market before the end of the year are not wholly reliant on their domestic market, and their geographical diversity should cushion them from any major concerns about the U.K. Merlin Entertainments, for example, has attractions across the U.S., Asia, the Middle East, and Europe alongside its U.K. holdings.

But while market participants are confident about the performance of upcoming deals, and note that each individual transaction will be judged on a deal-by-deal basis, some nervousness remains about U.K. risk. "There is certainly caution about the U.K.," said one senior banker. "For every transaction that comes across our desk, we’re having to think in some detail about how this business will be impacted post-Brexit, or how it will be impacted by a Labour government."

This caution seems to have increased as 2019 has progressed. Loan investors' appetite for the U.K. market has fallen over the year, with demand for British credits now falling behind the rest of Europe, having tracked the wider market more closely in the second half of 2018.

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Finding value
The expected upcoming boost in issuance from U.K.-domiciled firms comes on the back of a slump in British transactions in the leveraged loan market across 2019 to date — with U.K. issuance standing at just €8.31 billion for the year to Sept. 11 and accounting for 15% of the European loan market. This is down considerably on the same period last year, and only one full-year has recorded a lower market share this decade for U.K. borrowers, namely 2016.

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Much of this drop off is due to the fall in leveraged buyouts and M&A-related activity in the U.K. for the year to date, which is down nearly two-thirds on the same period last year.

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Sponsor interest

But the upcoming rush of transactions from U.K.-domiciled firms — all of which support buyouts — also reflects a surge in interest in British assets from sponsors. Certainly, the recent fall in the value of sterling increases the attractiveness of U.K. targets, as long as there is a clear story about how that target will weather Brexit.

The equity market’s bearish view on the U.K. also means there are opportunities for sponsors to look at public-to-private acquisitions in particular, or for overseas companies to step in. Just this week for example, Hong Kong Stock Exchange made a £32 billion unsolicited offer for London Stock Exchange Group PLC (with the £83.61 per share bid suggesting a 23% premium to the shares’ previous closing price), potentially scuppering the LSE’s agreed acquisition of financial information firm Refinitiv.

Overall though, many private equity buyers are taking a longer-term view of the political turmoil. "For a strategic acquirer, the fall in sterling does make U.K. assets more attractive,” said one manager at a U.S.-based private equity firm. "But from a sponsor perspective we are not in the business of placing positions in the value of sterling. We are making investments in businesses, not making derivative plays on currency”.

Sterling volume slumps
But while market participants are broadly confident about demand for U.K.-domiciled issuers — especially those with geographically diverse revenue streams, and that have a clear message about their resilience to Brexit — there is still concern about the depth of interest for loans raised in sterling. "Most of the risk we see is about currency, not country," said one private equity manager. "Trying to tap into sterling liquidity is incredibly hard, while CLOs that may have previously looked at sterling are now increasingly worried about the swaps they have to put in, and how expensive it could be to break them."

Overall, sterling-denominated leveraged finance volume has fallen in 2019, particularly in the loan market, with issuance of sterling-denominated high-yield bonds remaining more stable.

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Loan issuance in sterling stands at just €2.9 billion in 2019 so far (to Sept. 11). By comparison, in the same period last year the European market had seen some €7.64 billion of sterling issuance (with the full-year volume reaching €8.65 billion).

Supply across the European market has also fallen year on year — with the total volume of loans issued across Europe standing at €54.4 billion for the year to date, compared with €79.2 billion in the same period in 2018, and €96.7 billion across the full year. However, even within this envelope of shrinking issuance, the proportion of sterling debt has still fallen, to just 5.3% of the wider region’s loan issuance. Back in 2010, sterling debt made up 32% of the European loan market.

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The right stuff

However, market participants note there is still demand for sterling issuance, with tranches of up to £550 million still attainable for ‘the right credit’. "Sterling investors are still looking for opportunities to put money to work, and there just haven’t been the deals so far this year," said one banker. "Pricing remains important, as does the secondary performance, but there are still concerns about liquidity in sterling."

Certainly, sterling-denominated loan debt offers an increasingly deepening premium to euro issuance, with a differential of 1.77% in the average yield to maturity between the two currencies recorded in the first quarter for single-Bs.

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One investor notes that with swap costs at roughly 60 basis points, a 100 basis points pricing premium still offers investors a 40 basis points bump for playing in the sterling market. However, many question whether this premium is worth the corresponding loss of liquidity in the sterling secondary market.

Of the upcoming burst of issuance from U.K.-domiciled firms, only a few transactions are expected to carry sterling tranches. The £2.4 billion senior and second-lien financing backing Stonegate Pub Co.’s acquisition of Ei Group is currently denominated all in sterling, while vehicle auction site BCA Marketplace (which is now out with the financing backing its buyout by TDR Capital), is raising both euro- and sterling-denominated TLBs. Initial price talk on the two tranches suggests a premium of up to 2.09% on the yield of the sterling facility, while some investors note they may make sterling orders to increase their allocations on the euro facility.

Bonds buoyant

In contrast to the European leveraged loan space, the high-yield bond market has seen more stable issuance volume from U.K.-domiciled firms and sterling deals in recent years.

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In 2017, the market saw a spike in U.K. transactions as companies raced to raise financing ahead of a pick-up in Brexit risk, and since then volume has been depressed but stable. The supply of high-yield bonds denominated in sterling is similarly steady, standing at €3.83 billion-equivalent for 2019 (through Sept. 11), compared to €3.43 billion in the same period last year.
Moreover, in the European bond market U.K. issuers have retained the top spot in terms of issuance volume, dominating the league table in 2019 to date.

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Indeed, a transaction from film and T.V. studio firm Pinewood this week illustrated the potential depth of demand for U.K. names, with an upsized £550 million offering of sterling notes to take out a rough £280 million dividend, and pushing leverage to more than 8.5x, according to sources.

But this is not to say every U.K. issuer — or every sterling transaction — can sail through the high-yield bond market without a problem. Pinewood is an iconic brand, carrying a BB rating at a time when there is a hunt for yield and IG accounts are dipping down, and is perhaps now more akin to a property company in terms of how it's assessed.

In contrast, before the summer break, Domestic & General — which is a more consumer-facing extended warranty specialist — struggled with demand for the subordinated paper on its three-part bond offering. While the issuer was able to upsize its secured fixed-rate notes to £305 million from a planned £230 million, its secured floating-rate notes were switched to euros from sterling — again highlighting the need for CLO demand for floating-rate assets — while pricing on its sterling unsecured notes had to be boosted, finally coming at an offer price of 95.922.