- Rising first-lien leverage continued to drive the reduction in average expected recovery rates for new issuers in the first quarter of 2020 (to 58% in Q1 2020 versus 60% in 2019).
- Credit quality suffered as measures to contain the COVID-19 pandemic severely hit operating results, cash flow generation, and liquidity. Debt rated 'B' or below increased by €32 billion compared to the past quarter.
- Although expected first-lien debt recoveries, at 58%, were still broadly in line with the previous quarter, we see downside potential as corporates contemplate raising additional debt to shore up liquidity.
- If the economic downturn deepens, or an economic recovery fails to materialize at the forecast pace, we expect increased debt restructurings and defaults among more vulnerable issuers as liquidity dries up and leverage rises.
Strong Quarterly First-Lien New Debt Issuance Until Lockdowns
Speculative-grade new issuance and loan repricing actions were off to a strong start in the first two-and-half months of 2020, with €45 billion equivalent raised (see chart 1). This was brought to a halt in March as various governments imposed a string of restrictive actions to contain the COVID-19 pandemic that stilted economic activity across a myriad of sectors.
Marginally Lower Average Recovery Expectations, Higher Leverage
A recovery rating of '3' (indicating a meaningful recovery of 50%-70% in an event of payment default) was the most common assessment for first-lien new issues in Europe in first-quarter (Q1) 2020: over 82% of new rating assignments have expected recoveries in this category. The average expected recovery for rated first-lien debt during Q1 2020 was 58%, marginally below 60% for 2019 overall.
Average first-lien leverage levels during Q1 2020 were higher at 4.8x versus 4.5x in second half of 2019, 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). Loan repricings were often accompanied by debt add-ons, which led to 0.25x higher overall leverage. This was coupled with record low margins, averaging below 350 basis points for Q1. Investors have largely shrugged off rises in leverage, citing the benign interest rate environment, healthy cash interest cover ratios, and available cash to invest. Nevertheless, increased leverage is the key contributor to the slight downward trend in expected recovery levels.
The Business And Consumer Services Industry Issued The Most New First-Lien Debt
Nearly all first-lien new issuance we assigned in Q1 2020 has expected recoveries in a narrow band between 55% and 65% (see chart 2). In the financial services industry, there was a single issuer, SisalPay, which issued floating rate notes (FRN). The the size of priority-ranking debt affected the recovery expectations of these notes, at just 40%.
'BB' First-Lien Issuance Was Mostly To Refinance Existing Debt
Rated First-Lien New Issuance By Rating Category And Type Of Debt (Q1 2020)*
|--'B' category rated tranches--||--'BB' category rated tranches--|
|Amount issued (bil. €)||Average recovery (%)||Amount issued (bil. €)||Average recovery (%)|
|Loans (incl. revolving credit facilities)||29.4||56.5||6.6||67.1|
|*By value and average estimated recovery. Source: S&P Global Ratings.|
New first-lien issuance in the 'BB' category in Europe in Q1 2020 was by existing obligors, mainly to refinance existing debt at favorable rates and some add-on acquisition activity. Unlike in past years, term loans were the instruments of choice. This was largely driven by obligors such as Ineos Enterprises, Ineos Styrolution, and Telenet preferring to refinance via the loan markets.
Active 'B' Category Issuance Focused On Repricing Or Refinancing
First-lien issuance in the 'B' category was 3x more active than in the 'BB' category. This was largely driven by repricing or refinancing of existing tranches by issuers including Techem Verwaltungsgesellschaft 675 mbH, Nidda Healthcare Holding AG, and Markermeer Finance B.V. Debt-financed M&A activity was also buoyant, with several new issuers, most notable of which were AI Convoy (Luxembourg) S.a.r.l. (Cobham), AutoScout24 GmbH, Athena Bidco GmbH (P&I), and Loire Finco Luxembourg S.a.r.l (LGC Science).
Average recovery for newly rated debt in the 'B' category continued its downward trend to 58% in Q1 2020, compared with a 60% quarterly average for 2019 (see table 2). This was driven by:
- Increasing overall first-lien leverage, along with rising total leverage across sectors--mainly in media, software, and tech sectors, supported by high cash flow conversion rates.
- Debt add-ons backing M&A or dividend distributions by existing issuers, resulting in marginally higher adjusted leverage levels.
B' Category First-Lien New Issuance, By Value And Average Estimated Recovery
|--'B-' rated tranches--||--'B' rated tranches--||--'B+' rated tranches--||--Total 'B' category tranches--|
|Amount issued (bil. €)||Average recovery (%)||Amount issued (bil. €)||Average recovery (%)||Amount issued (bil. €)||Average recovery (%)||Amount issued (bil. €)||Average recovery (%)|
|Amounts updated for 2019 average euro exchange rates and conversion from preliminary to final ratings. Note that 2019 has been restated from previous reports to reflect preliminary to final ratings. Source: S&P Global Ratings.|
'B' rated new issuance reached €20 billion in Q1 2020, representing nearly 40% of the amount new issuance in that category during the whole of 2019. Loans continued to dominate European new issuance. At €4 billion, the issuance of first-lien bonds rated in the 'B' category was dwarfed by €24 billion equivalent of loan facilities issuance, nearly all of which comprised covenant-lite term loans (93% of all loan issuance) and revolving credit facilities (RCF).
Sponsor-backed issuers accounted for nearly 80% of the total new issuance in the 'B' rating category. Four sectors--health care, consumer, business services, as well as media, entertainment, and leisure--contributed over two-thirds of the activity.
Refinancing existing debt or repricings made up one-half of the new issuance, whereas M&A-related debt add-ons by existing issuers contributed one-third of overall volumes. New issuer activity, mainly through sponsor-backed leveraged buyouts (LBO), added another €9 billion in supply, including Cobham, AutoScout24, and Zayo Group.
Average Recoveries At 58%
As of March 31, 2020, we rated €689 billion equivalent of speculative-grade corporate debt, comprising 673 European obligors. Rated first-lien debt amounted to €469 billion equivalent (see chart 3), including committed RCFs and excluding defaulted debt.
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.
Debt in the 'BB' category shrunk by €11 billion net, driven by downgrades and a limited increase from fallen angels (issuers with ratings declining from investment-graded to speculative-grade categories). 'B+' rated first-lien debt decreased by €14 billion, due to downgrades. As a result, 'B' rated debt increased by €14 billion compared to the previous quarter, largely underpinned by rating actions on Altice Financing S.A., Nidda Healthcare Holding AG, Auris Luxembourg III S.a.r.l., and Loxam SAS.
'B-' rated debt also increased by €5 billion. The amount of first-lien debt in the 'CCC' category or below increased by €5 billion equivalent, largely driven by downgrades from debt previously rated 'B-'.
Downgrades Dominated, Especially In Industries Worst Hit By COVID-19 Measures
S&P published 100 rating actions in the European speculative-grade rating categories in Q1 2020, of which 91 were downgrades (excluding defaults) during the first quarter (see chart 5). Unsurprisingly, retail, consumer products, media, entertainment and leisure, and the oil sectors contributed nearly two-thirds of these downgrades. The trend continued in April, bringing the total to 136 rating actions.
There were five fallen angels during Q1 2020. Four of these were Italian obligors: transport-related Aeroporti di Roma and Atlantia, real-estate owner Immobiliare Grande Distribuzione SIIQ S.p.A. and premium food retailer Esselunga. Esselunga's downgrade was mostly related to a debt-backed minority shareholder squeeze-out, offset by solid operating performance and cash flow generation. We downgraded Marks & Spencer PLC to 'BB+' as the negative impact on sales in its clothing and home division were only partially mitigated by its food segment, including pick-up in online sales.
If the negative real economy downturn deepens, or recovery fails to materialize at the forecast pace, we also expect increased debt restructurings and defaults as more vulnerable issuers exhaust sources of liquidity and crumble under their burgeoning leverage.
Highest Recoveries In Telecoms And Media And Entertainment
Speculative-Grade European First-Lien Debt And Average Recovery By Industry
|S&P Rated First Lien Debt (by Industry)||Amount outstanding (bil. € eq.)||Average recovery (%)||Standard deviation|
|Media, Entertainment & Leisure||57||63||12|
|Business and Consumer Services||46||55||11|
|Packaging / Building Mat / Forest Prod||32||61||17|
|Restaurants & Retailing||28||57||15|
|Cap Goods / Machine & Equipment||22||52||14|
|Auto / Trucks||12||59||13|
|Financial services (non-bank)||6||58||16|
|Aerospace & Defense||5||53||10|
|Mining & Minerals||1||65||17|
|Source: S&P Global Ratings.|
By sector, technology, media, and telecom 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 expected first-lien recovery remained broadly in line with the previous quarter at 58.3% (see table 3). From the top 5 sectors by debt outstanding, those with the highest average recovery are telecommunications (62%) and media, entertainment, and leisure (63%). Health care and consumer services have the lowest average recoveries at approximately 55%.
According to our estimate of post-default recovery of all first-lien senior secured debt outstanding that we rated as of March 31, 2020, the average expected recovery for all senior secured rated debt is 58.2%, compared to 58.5% at the end of 2019 (see chart 6). Altice Financing S.A. and Altice France S.A. contribute over €26 billion equivalent (in U.S. dollars and euro) within the 60% expected recovery bucket. Various tranches issued by Virgin Media and Ziggo contribute nearly one-third, or €28 billion equivalent in the 65% expected recovery bucket.
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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