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Leveraged Finance: European Leveraged Finance And Recovery Fourth-Quarter 2020 Update: Leverage Increases, Recovery Slips

Despite a rising number of defaults and a reduction in offerings from debut issuers in the fourth quarter of 2020, new European speculative-grade issuance remained healthy given the broad macroeconomic context, but significantly lower than before the pandemic. S&P Global Ratings rated €40 billion of new speculative-grade debt in the quarter. The scarcity of new transactions pushed leverage higher on the few new offerings that emerged during the second half of the year. In contrast, existing issuers largely resorted to maxing out their permitted debt, either to meet their liquidity needs during the pandemic, or to fund an opportunistic add-on merger or acquisition (M&A). In turn, this led to a further decrease in the average recovery rate for first-lien speculative-grade debt to 57%. The combination of increasing prospects of recession in the eurozone, and worsening credit metrics and quality, may mean that defaults and preemptive restructurings continue in 2021, particularly among companies adversely affected by lockdown measures.

New First-Lien Speculative-Grade Issuance

The average recovery rate dropped as issuers took on more debt

New first-lien, or senior secured, tranches contributed €22 billion to total European speculative-grade issuance in the fourth quarter of 2020. The average expected recovery rate for new first-lien debt dropped from previous quarters to 55% in fourth-quarter 2020 (see chart 1), for two main reasons. First, add-on debt to support tuck-in M&A led to a higher proportion of senior secured debt in the capital structures of existing issuers. Second, opening senior secured leverage for new sponsor-backed transactions increased by about 0.25x on average, as LCD News reported.

Chart 1


'B' category issuers dominated

Issuers rated in the 'B' category raised €16 billion in new speculative-grade first-lien debt in the fourth quarter (see table 1). The return of 'B' rated issuance was supported by buoyant secondary markets, which, fueled by benign monetary policy and positive tailwinds from the COVID-19 vaccine rollout in most European countries, have reverted to pre-pandemic pricing levels. Having said this, the market remains unreceptive to companies adversely affected by additional lockdowns, unless they have received support from their sponsor owners. This was the case for travel and accommodation distributor Hotelbeds, which received a cash injection from its owners in the form of a shareholder loan to its parent, HNVR Midco Ltd.

Table 1

Rated First-Lien New Issuance By Rating Category And Type Of Debt
Q4 2020, by value and average estimated recovery
'B' category rated tranches 'BB' category rated tranches
Amount issued (bil. €) Average recovery (%) Amount issued (bil. €) Average recovery (%)
Loans (including RCFs) 9.6 56.0 2.2 66.3
Bonds 6.4 51.2 2.1 60.0
Total 16.0 54.5 4.3
RCF--Revolving credit facility. Source: S&P Global Ratings.
The amount of new first-lien issuance remains limited

New first-lien issuance remains scarce in the European leveraged finance market, with only €22 billion of speculative-grade first-lien debt issued in the fourth quarter of 2020, 50% less than in the first quarter of 2020. New first-lien issuance was driven by a mix of refinancing, debt-funded M&A add-ons, and new transactions. For example, Norwegian classifieds operator Adevinta ASA--rated 'BB-' on a preliminary basis--raised €2.4 billion in new debt to finance its purchase of eBay Classified Group and refinance its existing debt. Although new sponsor-backed supply remained uncommon, notable transactions included:

  • BC Partner's partial acquisition of Italian automated machine manufacturing firm SOFIMA Holding SpA, funded with €1.3 billion of new senior secured debt and €310 million of payment-in-kind (PIK) debt;
  • IK Investment Partner's acquisition of French food safety company Kersia International, backed by €450 million of new debt, which also included a margin linked to an environmental, social, and governance target; and
  • Ardian's acquisition of French diagnostics laboratory operator Inovie Group, supported by a €910 million term loan.

New M&A-driven debt add-ons also trickled through. Dutch specialty ingredients distributor Barentz Bidco B.V. raised €585 million equivalent in term loans to fund its acquisition of U.S.-based Maroon; German pharmaceuticals firm Cheplapharm Arzneimittel GmbH issued €1 billion to fund the acquisition of four product portfolios; and Dutch software provider Precise Midco B.V. (Exact) acquired Unit4's Dutch and Belgian accountancy operations.

Aston Martin Holdings (UK) Ltd. found a receptive audience once again when issuing $1 billion of new senior secured notes, alongside a new equity offering and subordinated debt issuance, in order to repay existing debt and boost liquidity. Credit management solutions provider Garfunkelux Holdco 2 S.A. (Lowell) stabilized its financial profile through a €1.7 billion three-part senior secured debt issuance, coupled with a £600 million capital injection by the sponsors. Finally, vending machine operator Selecta Group B.V., travel commerce platform Travelport, and paper products manufacturer Torraspapel S.A. (Lecta) emerged from restructuring with combined senior secured debt of €2.2 billion, all involving the issuance of additional super-priority debt to boost liquidity.

Outstanding First-Lien Speculative-Grade Debt

The average recovery rate dropped slightly

As of Dec. 31, 2020, we rated €768 billion equivalent of speculative-grade debt from 707 European corporate issuers. Rated first-lien senior secured debt amounted to €503 billion equivalent, including committed revolving credit facilities (RCFs) and defaulted debt. The average recovery rate on this debt at year end-2020 was 57%, slightly lower than 59% at the end of 2019 (see chart 2).

Chart 2


A recovery rating of '3', indicating our expectation of a recovery rate of 50%-70%, remains the most common recovery rating for first-lien speculative-grade debt in Europe (see chart 3). Our expected recovery rate remains on average much lower than the actual average first-lien recovery rate of 73% over 2003-2009 (see "European Corporate Recoveries Over 2003-2019: The Calm Before The COVID-19 Storm," published Aug. 5, 2020, on RatingsDirect).

Chart 3


Telecoms companies have the largest share of debt

By sector, telecoms is the largest contributor to rated European speculative-grade senior secured debt, followed by media and entertainment, health care, and consumer products (see chart 4). However, these sectors have broadly stable recovery outcomes, with a standard deviation of 5%. The largest variability in recovery outcomes is within the automotive and transportation sectors, followed by oil, mining, and capital goods. This is due to the capital-intensive nature of these sectors, the amount of priority debt, and excessive leverage, as these sectors faced challenging growth and profitability conditions even prior to the pandemic.

Chart 4


Loans fare better than bonds in the recovery stakes

Loans, on average, have higher expected recovery rates than bonds (see table 2). For issuers rated 'B+' or below, this is because of the presence of a super senior RCF in bond-only capital structures. For 'BB' category issuers, reasons include higher leverage on average for those tapping the high-yield capital markets, and the frequent presence of factoring or securitization facilities, which we deem to have priority.

Table 2

Rated European First-Lien Debt Recovery By Rating Category And Type of Debt
As at Dec. 31, 2020, by value and average estimated recovery
'CCC+' or below rated tranches 'B' category rated tranches 'BB' category rated tranches
Amount outstanding (bil. €) Average recovery (%) Amount outstanding (bil. €) Average recovery (%) Amount outstanding (bil. €) Average recovery (%)
Loans (excluding RCFs) 34.5 52.4 245.3 56.7 50.1 63.5
Bonds 13.7 52.2 89.5 55.0 41.7 60.1
Total 48.2 52.3 334.8 56.2 91.8 61.8
RCF--Revolving credit facility. Source: S&P Global Ratings.

That said, 'BB' category issuers predominantly resort to unsecured debt issuance to finance their capital needs. Some 63% of all debt rated in this category is unsecured, excluding RCFs. Interestingly, 'BB' rated issuers have favored the bond markets for raising unsecured debt. We have rated €149 billion of notes in this category, compared to €9 billion of loans and €14 billion of RCFs. The average recovery rates for unsecured loans and bonds are broadly similar, and correlate with the rating category. Unsecured debt rated 'BB' and 'BB-' has an average expected recovery rate of 56%, whereas unsecured debt rated 'BB+' has an average expected recovery rate of 63%.

Telecoms issuers remained the most prominent in the 60%-65% recovery buckets in the fourth quarter of 2020, with over €60 billion of outstanding debt. An exception is our expectation of 0% recovery for IHO Verwaltungs GmbH's senior secured debt due to the company's new fallen angel status. We assigned IHO Verwaltungs' senior secured PIK toggle notes a recovery rating of '6' due to its dependence on dividends from its two holding companies and structural subordination to a significant amount of debt at its majority owned subsidiary, German auto and industrial component supplier Schaeffler AG.

Weak Credit Quality Means Defaults Will Continue Into 2021

The credit quality of European speculative-grade issuers stabilized in the second half of 2020, as most rating actions and downward rating migration happened in the first half of the year. Nevertheless, credit quality is significantly worse than at the end of 2019: the number of 'B-' rated issuers has increased by 51 and the number of issuers rated 'CCC+' and below has nearly tripled to 86, corresponding to 22% and 10% of all speculative-grade issuer credit ratings at the end of the fourth quarter (see chart 5). Credit risk remains considerable, as 227, or 38%, of all European speculative-grade issuers carry a negative outlook. This situation is particularly acute at the lower end of the rating spectrum, that is, 'B-' and below.

Chart 5


On a positive note, the amount of first-lien debt per rating category was relatively stable in the fourth quarter of 2020, both by nominal amount and percentage of the total issuance (see chart 6). First-lien debt rated 'B-' increased by €7 billion, driven by rating actions and new issuance in the software and high technology sector. The amount of first-lien debt rated 'B' and 'B+' was largely unchanged. Conversely, the amount of debt rated 'CCC+' or below fell by €4 billion, reflecting upgrades to 'B-'. First-lien debt rated 'B-' and below constitutes €146 billion, or 29%, of all the European senior secured debt outstanding. Debt rated 'D' (default) decreased in the last quarter of 2020 to €4.4 billion, compared to €7.1 billion in the third quarter.

Chart 6


In addition, the negative outlook bias remained stable or even shrank slightly quarter on quarter across the credit rating spectrum, reflecting the reduced pace of rating actions in the second half of the year following the peak in April and May (see chart 7). Issuers in the 'BB' and 'B-' categories were the exceptions, where the negative outlooks bias decreased markedly thanks to outlook stabilizations on better performance than we expected, rating changes, and CreditWatch resolutions. There were 20 issuers (3% of 606) on CreditWatch negative at the end of 2020, compared to two issuers at the end of 2019.

Chart 7


The media, entertainment, and leisure, retail, auto, transportation, and aerospace sectors have the highest proportion of negative outlooks, equating to 167 issuers, or 28% of all sectors, excluding infrastructure and financial services (see chart 8). These issuers are therefore most vulnerable to further negative rating actions. Sectors least affected by the pandemic include health care, technology, telecoms, and pockets of business and consumer services, where only one-quarter of rated issuers carry a negative outlook. These sectors also had the lowest proportion of negative rating actions in 2020.

Chart 8


Nearly half of all rating actions in the fourth quarter were downgrades

S&P Global Ratings took 90 rating actions on European speculative-grade companies in fourth-quarter 2020, of which 43 were downgrades (excluding defaults), including one fallen angel (see chart 9). As in the previous quarter, the media, entertainment, and leisure sector saw most downgrades, followed by business and consumer services and transportation.

Chart 9


There were 24 upgrades in the fourth quarter, the majority in the consumer products and high technology sectors. Of this 24, seven followed better performance than we expected after downgrades in the first wave of the pandemic. In addition, we upgraded 12 issuers following their emergence from restructuring or default, bringing the total number of upgrades to 36 during the fourth quarter. There was only one fallen angel during fourth-quarter 2020, increasing the total number in 2020 to 20.

We downgraded 11 issuers to 'D' (default) or 'SD' (selective default) in the fourth quarter--slightly less than in the previous quarter--increasing the number of defaulted issuers in 2020 to 40 from 15 in 2019. Almost all the defaulted companies were in the 'CCC' rating category prior to default, except Spanish ferry group Bahia de las Isletas, S.L. and Spanish real estate company Haya Real Estate, S.A.U. At the same time, the number of issuers rated 'CCC' or below decreased, leading to a drop in the amount of first-lien debt outstanding at these issuers to €16 billion.

Preemptive restructurings abounded in the second half of the year

Most issuers restructured in the second half of 2020 for reasons other than a shortage of cash. Many moved to address weaknesses in their capital structures sooner rather than later. Owners and lenders often view a strategic restructuring with sufficient liquidity as the best course of action to preserve value (see "European Corporate Defaults: Owners Step Up To Mend Pandemic-Hit Capital Structures," published Jan. 13, 2021).

While first-lien lenders have managed to preserve the relative priority of their exposure, this came largely at the cost of committing new money in the form of priority debt to boost issuers' liquidity, albeit at better pricing. Private equity sponsors have largely been supportive of their issuers, either through additional pari passu or priority debt, or equity injections, or both, paving the way for relatively amicable and swift restructurings. Loose documentation provisions allow private equity owners, by and large, to exercise various transfers of collateral away from the grasp of existing lenders, but we have not seen them resorting to this strategy. Travelport was the only exception in 2020, although the transfer was reversed and a more lender-friendly structure was ultimately put in place.

Related Research

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
Additional Contact:Industrial Ratings Europe;

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