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Leveraged Finance: European Leveraged Finance And Recovery Fourth-Quarter Update And Full-Year Summary

Quarterly First-Lien New Debt Issuance And Average Recovery Expectations Are Negligibly Lower

Although speculative-grade 2019 new issuance volume is well below last year's, S&P Global Ratings has seen increased activity in the leveraged loan and speculative-grade bond markets in the second half of the year, with nearly €76 billion equivalent of first-lien speculative-grade debt either priced or being marketed to investors (see chart 1).

A recovery rating of '3' (indicating a meaningful recovery of 50%-70% in an event of payment default) remains the most common assessment for first-lien new issues in Europe, with over 82% of new ratings assigned expected recoveries in that category. The average expected recovery for rated first-lien debt during fourth-quarter 2019 was stable at 59% and a touch below 60% for 2019 overall.

Average first-lien leverage levels reached a record high in 2019 at 4.8x, according to Leveraged Commentary & Data (an offering of S&P Global Market Intelligence, a division of S&P Global, as is S&P Global Ratings). S&P Global Ratings-adjusted first-lien leverage is typically 1.5x higher than marketing leverage (see "How Leveraged Are European Leveraged Finance Transactions?" Dec. 3, 2019). Existing issuers on the M&A path tend to finance acquisitions solely through debt, which typically leads to relevering at initial leverage levels or a little higher. Given the higher number of larger issuers, a benign interest rate environment and strong demand for collateralized loan obligations (CLOs), investors have largely shrugged off the rising leverage trend, though it is one of the contributors to the slight downtrend in expected recovery levels. Rising leverage has however brought to the fore concerns surrounding adjustments to EBITDA. Spin-off transactions for Kantar (Summer (BC) Lux Consolidator S.C.A.) and CRH Europe Distribution (Clay Holdco B.V.), which had sizable add-backs (adjustments to reported EBITDA) driven by cost initiatives at the start of the debt syndication process, had the amount of add-backs capped at 25% eventually, as investors expressed skepticism in supporting the full number that management and sponsors identified. S&P Global Ratings normally heavily discounts add-backs and considers their cost of implementation, which further leads to lower expected recovery.

Chart 1


Strong and continued new issuance momentum in launching CLOs, and the need to ramp-up investment, has meant that leveraged loan pricing continued tightening across the credit rating spectrum. This has not only applied to new issuance, as from September onward we witnessed several term leveraged loan add-ons pricing at par or a little above par, which is highly unusual. The last quarter of the year also sparked a wave of leveraged loan repricing requests, which is continuing into 2020 as the soft call period expires in deals priced in the first half of 2019.

2019 European first-lien new debt issuance recovery, by rating category and debt type

Table 1

Rated First-Lien New Issuance By Rating Category And Type of Debt, 2019

'B' category rated tranches 'BB' category rated tranches
Amount issued (bil. €) Average recovery (%) Amount issued (bil. €) Average recovery (%)
Loans (including revolving credit facilities) 83.0 59.00 10.8 66.80
Bonds 23.4 58.60 22.2 62.90
Total 106.6 58.80 33.0 64.20
Source: S&P Global Ratings.

New first-lien issuance supply rated in the 'BB' category in Europe has been by existing obligors, mainly refinancing drawn revolving credit facilities or existing debt at favorable rates, particularly in the bond markets. Over two-thirds of the 'BB' category debt issuance in 2019 has been by bonds, through a mix of maturity dates as issuers try to lock in low interest rates.

Given the growing volume of negative-yielding investment-grade bonds, demand for speculative-grade bonds has increased. This drove another surge in the fourth quarter by 'BB' category rated issuers, refinancing their existing debt to lock in lower interest rates and extend maturities. Second-half bond market primary issuance was further lifted by 'B' category rated big buyouts and M&A related financings, with over €10 billion raised for this purpose. These transactions included Merlin Entertainment PLC (Motion Midco Ltd.), Kantar, and EG Group, among others.

S&P Global Ratings expects higher overall recovery expectations associated with loans versus bonds in the 'BB' rating category. This is largely company- and sector-specific rather than debt-specific, mainly due to the size of the revolving credit facility (RCF) and its size compared with that of other pari passu debt and the presence of priority-ranking debt, such as asset-back loans, securitization facilities, and similar types of financing.

2019 European first-lien new debt issuance recovery, by industry

Chart 2


Average health care sector recovery rates were dragged down by those for Synlab Bondco PLC, Rossini Sarl, and Rodenstock GmbH, all of which have an expected recovery rating of '4'. Synlab and Rossini were due to burgeoning first-lien levels and competitive pressures, whereas Rodenstock emerged from a restructuring earlier in the year. Excluding these three outliers, the average expected recovery would have been about 55%-60%. The aerospace and defense data point represents one issuer, Ontic (Bleriot Midco Ltd.).

Focus on new issuers in the 'B' rating category, year-to-date fourth-quarter 2019

The same theme carries further down the credit spectrum. As appetite and demand for paper continues, fueled by continued strong momentum of European CLO issuance in particular, secondary and new issue pricing levels continued to tighten. This has created an issuer-friendly environment. Investors' power to impose market discipline regarding credit quality is mostly limited to asking for higher coupons and perhaps a slight tightening in incurrence covenants (those that must be met only at the time of incurrence), but little else for issuers that investors deem "must haves" for their portfolios.

New issues rated 'B+' dominated volumes in fourth-quarter 2019, representing over half of total 'B' category rated first-lien new issuance, driven by debt refinancing by existing issuers such as Ziggo B.V., Springer Nature, IFCO Management GmbH, Jaguar Land Rover Automotive PLC, and Casino Guichard - Perrachon S.A. New issuers in this rating category included Merlin Entertainments, Affidea, and Kiloutou.

Average recovery for newly rated debt in the 'B' category during the fourth quarter was 57%, same as the previous quarter and a little below 59% for 2019. The reasons include:

  • Increasing overall first-lien leverage, along with total leverage, particularly for first-time issuers.
  • Debt add-ons backing M&A by existing issuers were mostly wholly debt-financed, resulting in marginally higher adjusted leverage levels because we overall apply more conservative pro forma adjustments.
  • Increased issuance in media, software, and tech sectors, which are characterized by lower estimated recoveries because their business models are asset-light and based on difficult-to-value intellectual property, content, and know-how.

Table 2

Single-B Rated First-Lien New Issuance, By Value And Average Estimated Recovery

'B-' rated tranches 'B' rated tranches 'B+' rated tranches
Amount issued (bil. €) Average recovery (%) Amount issued (bil. €) Average recovery (%) Amount issued (bil. €) Average recovery (%)
1Q18 5.0 45.94 13.9 50.60 9.6 50.30
2Q18 3.0 47.14 14.4 50.30 3.9 63.00
3Q18 0.8 49.00 12.8 54.10 16.9 52.10
4Q18 1.5 60.56 16.5 55.40 8.1 55.60
1Q19 1.7 62.50 11 56.60 9.6 64.30
2Q19 1.7 65.00 17.8 58.70 7.3 60.30
3Q19 (Updated) 5.5 59.06 16.1 56.10 7.8 59.20
4Q19 2.9 55.90 9.3 52.20 15.6 63.20
Since January 2018 22.2 54.90 111.9 54.30 78.7 58.10
2019 11.9 59.90 54.2 56.50 40.1 61.80
Note: 3Q19 has been restated to reflect preliminary to final ratings; amounts updated for 2019 average euro exchange rates and conversion from preliminary to final ratings. Source: S&P Global Ratings.

Loans continued to dominate European new issuance in 2019. At €23 billion, the issuance of first-lien bonds rated in the 'B' category was dwarfed by €83 billion equivalent of loan facilities issuance, nearly all of which comprised covenant-lite term loans (93% of all loan issuance) and RCFs.

M&A-related activity (leveraged buyouts (LBOs) and M&A-related debt add-ons) gave rise to more than half of the primary loan supply for the year. New issuer activity was also prevalent, particularly in the first and third quarter of the year. Corporate spin-offs and public-to-private deals were all well received, clearly highlighting a bias toward large and established assets by investors such as Merlin Entertainments PLC, Power Solutions, Galderma (Sunshine Luxembourg VII, formerly Nestle's skin care division) and CRH Europe Distribution. This did not always translate to tighter pricing for all, as investors remained cautious when it came to credits perceived as challenging--turnaround stories, competitive end-market pressures, or simply, business models not intuitively and easily understood, such as Kantar.

'B-' rated issuance reached €3 billion in the fourth quarter and €12 billion for the year (an increase of €2 billion compared to 2018 issuance). First-time issuers, Ontic and The Hut Group Ltd., contributed €1 billion of new issuance, whereas the remaining comprised refinancings and M&A backing add-on debt for existing issuers. Including the proposed financing backing Sophos Ltd.'s acquisition by Thoma Bravo (Surf Intermediate I Ltd.), which was announced in December but whose lender meeting was in January 2020, the total for the quarter would have been €5 billion.

S&P Global Ratings estimates average corporate recoveries on all currently rated European first-lien debt at 59%

As of year-end 2019, we rated €641 billion equivalent of speculative-grade corporate debt comprising 809 European obligors. Rated first-lien debt amounted to €458 billion equivalent, including committed RCFs (excluding defaulted debt).

Chart 3


A '3' recovery rating remains the most common assessment for first-lien new issues in Europe, comprising nearly three-quarters of total rated debt outstanding. In that group, 36% comprise issuers with a 'B' rating (versus 38% in third-quarter 2019), another 26% are 'B+' rated issuers (versus 24% in third-quarter 2019), and 12% are 'B-' rated issuers (versus 11% in third-quarter 2019). The amount of 'B-' rated debt has increased to €55 billion from €52 billion, largely because of downgrades and limited new issuance in the last quarter of the year. The amount of first-lien debt in the 'CCC' category or below remained flat at €18 billion equivalent.

Chart 4


Chart 5


The fourth quarter featured 23 downgrades in the 'B' rated category bringing the total to 54 for the year. This led to an increase in 'B-' rated debt by €13 billion and 'CCC+' rated debt by €12 billion. The net impact on the overall distribution of debt by rating category was muted, however, as the amount of debt impacted by upgrades was similar.

We have taken 136 ratings actions in the European speculative-grade rating categories in 2019, of which 75 were downgrades (excluding defaults), with retail, consumer products, entertainment, and leisure and capital goods sectors contributing nearly two-thirds. Issuers domiciled in the U.K. contributed nearly one-third of the downgrades, reflecting Brexit uncertainty overhang, a weaker operating environment, and exposure to vulnerable sectors such as retail, capital goods, and aerospace.

In addition, we assigned negative outlooks on 71 companies as slowing consumer spending, structural industry changes commanding higher capital investment, rising input costs, and anemic economic growth weighed on profitability and cash flow generation.

We downgraded 15 obligors to 'D' (default) or 'SD' (selective default) in 2019, nearly half of which were U.K. based from a mix of consumer and retail sectors. U.K.-domiciled defaulted companies included New Look Retail Group Ltd., Debenhams PLC, Thomas Cook Group PLC, PizzaExpress Group Ltd., and Survitec. Three obligors defaulted in Germany that were active in the capital goods sector (Galapagos S.A., Senvion Holding GmbH, and Bartec) and a further three were French from a variety of sectors (chemicals, health care, and retail). Also included in the number of defaults was Mallinckrodt PLC, which we downgraded after it undertook a distressed exchange on its debt. We upgraded Mallinckrodt back to 'CCC' because the risk of further distressed exchanges or debt restructuring persists.

Top drivers in key sectors for the negative rating actions, including the defaults, were:

  • Capital goods: Continually weakening operating environment and a cash squeeze due to a high interest burden and working capital outflows, leading to an unsustainable capital structure or an inability to service debt.
  • Retail and consumer sectors: Intense competition eroding margins due to an ongoing shift to e-commerce and changing consumer preferences.
  • Health care: Limited pricing uplift potential, particularly to players exposed to government-driven volumes, coupled with increases in operating costs that squeezed margins. Furthermore, fully debt-funded add-ons increasingly provided limited synergies as valuations steadily crept up.
  • Aerospace and defense: Exposure to affected original equipment makers such as Boeing and Rolls Royce, particularly for U.K.-based companies.

Table 3

Speculative-Grade European First-Lien Debt And Average Recovery, By Industry

Rated by S&P Global Ratings
(By industry) Amount outstanding (bil. € eq.) Average recovery (%) Standard deviation
Telecommunications 83 62 13
Media, Entertainment & Leisure 57 64 12
Healthcare 52 54 13
Business and Consumer Services 42 55 12
Consumer Products 37 58 9
High Technology 35 59 9
Chemicals 33 59 6
Packaging / Building Mat / Forest Prod 32 62 18
Restaurants & Retailing 30 56 16
Cap Goods / Machine & Equipment 20 51 14
Auto / Trucks 13 59 14
Transportation 8 63 16
Financial services (non-bank) 6 58 16
Oil 4 62 17
Aerospace & Defense 2 55 9
Real Estate 2 82 10
Mining & Minerals 2 64 16
Total 458 59 13
Source: S&P Global Ratings.

By sector, TMT is the largest contributor to outstanding European senior secured debt that we rate, followed by media, entertainment and leisure, health care, consumer products, and business and consumer services.

Overall, average recovery remained broadly the same as last quarter. From the top 10 sectors by debt outstanding, those with the highest average recovery are media, entertainment, and leisure (64%), while capital goods has the lowest at 51%.

Chart 6


Chart 6 shows the distribution, according to our estimate of post-default recovery, of all first-lien senior secured debt outstanding that we rated as at the end of 2019. The average expected recovery for all senior secured rated debt is 58.5%. Altice Luxembourg SA was the sole issuer in the 15% estimated recovery bucket, with nearly €10 billion equivalent in senior secured notes outstanding, rated 'B-'. More than half of the 30%-40% estimated recovery bucket consists of debt issued by three sectors, capital goods, packaging and building products, and health care. The 65% expected recovery bucket has increased by €28 billion since last quarter, due to two individual issuers. Virgin Media Inc.'s €10 billion senior secured debt expected recovery increased from 60% and VodafoneZiggo Group B.V.'s €18 billion senior secured debt recovery increased from 55%.

This report does not constitute a rating action.

Primary Credit Analyst:Marta Stojanova, London + 44 20 7176 0476;
Secondary Contact:David W Gillmor, London (44) 20-7176-3673;
Research Contributor:Maulik Shah, CRISIL Global Analytical Center, an S&P affiliate, Mumbai

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