Wednesday, 23 January 2019

Anything but boring

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Lumpy. Buyer-friendly. Aggressive. Frothy. Boundlessly contrary. Syndicate managers use many words to describe the high-yield market this year, but ”uninteresting” is not one of them.

Indeed, the sector surprised issuers, managers and investors right from the start. Jermaine Jarrett, head of high-yield bond syndicate at Credit Agricole, expected rates to go up by mid-year and spreads to widen. Neither happened.

“We expected the pace of opportunistic refinancings to slow and that new issuance would be more event-driven,” he said.

Again confounding expectations, refinancing bounced to record post-crisis highs while acquisition-driven financing was one of the great unheralded capital markets stories of the year.

Looking back, the early part of the year seems like another country. Volumes were high but not startlingly so. It was only when France’s Numericable and Luxembourg’s Altice joined forces in April to buy Vivendi’s phone unit that the market found a higher gear.

That deal made history twice, both in terms of its overall size and the total books, with the €12bn equivalent trade securing US$100bn in orders. Some deal tranches were 10 times oversubscribed, ushering in a stellar few months through early summer.

Nor was that the only deal to whet investor appetites. Wind blew into the market in June to issue a bumper €4.575bn mix of euro and dollar-denominated floating and fixed-rate paper, taking total issuance by the Italian telecoms firm to €8bn equivalent in just three months. Syndicate bankers were hard pushed to remember a better and more protracted passage of time for European high-yield.

Lulls and jumbo deals

And the deals just kept coming. Total European high-yield issuance hit US$145bn in the first nine months of the year, up from US$100bn in the same period a year ago, according to data from Thomson Reuters. Total global issuance hit a record US$505bn in the first nine months of 2014, beating the US$454bn posted a year earlier.

Nor, unlike much of the post-crisis era, has the year been one of long lulls punctuated by a few, frenetically finalised jumbo trades. Smaller trades have kept the markets rolling along, boosted by first-time SME issuers from the likes of France, Germany and Italy.

Such deals may take longer to get to market, and bankers have at times grumbled at taking on quarter-billion-dollar deals when most, said Paul Gibbon, head of leveraged finance capital markets at UBS, would “prefer to be processing larger US$400m, US$500m, deals which exhibit better liquidity in the after-market”.

But the fact that first-time European corporate issuers from the likes of France, Germany and Italy are willing to make the journey at all is testament, said Tanneguy de Carne, head of non-investment-grade capital markets at Societe Generale, to the market’s increasing “depth and maturity, as well as proof that the market is accepting more mid-cap corporates”.

It hasn’t been entirely smooth-sailing. Deal activity slowed sharply in late July and August, as investors took fright at a frothy market and uncertainty in Ukraine. Many saw that as a logical reaction, said Chetan Modi, co-head of European leveraged finance at Moody’s, to “a market that had grown too fast and was looking for a trigger, and Ukraine happened to be trigger”. Funds flowed out of loans and bonds; pricing fell back.

Hitting the skids

A scattering of deals also hit the skids. In late July, French industrial firm Winoa pulled a planned €260m non-call, senior secured issuance. The following week, Poland-based retailer EM&F’s attempt to complete a €240m print of senior unsecured notes stalled, despite talk of a chunky yield estimated at 8.5%–8.75%.

In truth, neither sale was ideal. Winoa was undermined by misgivings about the speed with which private equity major KKR sought to refinance a firm it only bought in early 2014, with investors casting their minds back to Gala Coral’s accelerated 2011 bond sale.

EM&F was hobbled by more strategic concerns. 

There was, said Credit Agricole’s Jarrett, a “lot of doubt about their future. They sell books and music in Poland and Ukraine and the increase in competition – we know Amazon is coming – drew concern around deleveraging potential and their lack of geographic diversification.”

In truth, neither deal was a must-have trade. Market conditions didn’t help: Alain Stalker, managing director, DCM syndicate, at SG said there would “arguably have been enough support” for both deals, had they been issued into a stronger market.

Credit Agricole’s Jarrett said both were “weak and challenging credits” further undermined by being launched into a market heading into the summer break. Besides, all markets, particularly those succumbing to a frothy period, need a deal or two to fail once in a while. What markets actively seek to avoid – and have done so far this year in the high-yield space – is prolonged shut-down.

Subtly different place

When markets returned to action in September, the high-yield world was a subtly different place. Investors had became pickier about credits. Yields spiked in the wake of the collapse of UK retailer Phones4u, which left high-yield bondholders on the hook for as much as £275m.

All of a sudden, deals needed a little extra sweetening. Issuers and syndicate managers were forced to tweak covenants and bolster yields. Nyrstar’s €350m sale of senior unsecured notes due 2019 was printed in September only after the Belgian smelter agreed to bump up pricing by around 250bp. UK housing renovation play KeepMoat finalised a £260m sale of five-year senior secured notes only by agreeing to an eye-watering yield of 9.75%.

Both deals highlighted a sudden “flight to quality to less aggressive deals”, said SG’s de Carne. And both deals were only priced after issuers demonstrated flexibility on covenants. KeepMoat was forced to drop a portability feature during its roadshow, while Nyrstar, already a curio in the high-yield space given its sector, had to adjust its non-call period to non-call life from non-call two.

Weaker covenants, a slow-burn issue for a couple of years, suddenly bubbled up again around mid-year. Even syndicate managers agree that covenants have become increasingly aggressive, from portability features to additional flexibility over re-leveraging, limitations on restricted payments.

Sandra Veseli, co-head of European leveraged finance at Moody’s, points to a surge in deals with large subordinated positions.

“We’ve seen a deterioration of covenant clauses and protection, and have seen the first all-European covenant-light transactions,” she said. “That’s a red line that has been crossed and a real driver for the popularity of these covenant-light deals, which originated in the US but have now crossed into Europe.”

Quality warning

Veseli noted, too, that a handful of recent issuers had additional leverage capacity in their documentation allowing them to raise debt equal to four times Ebitda. That, she said, was “significant. Not everyone will use all that leverage capacity and we do not rate to that scenario, but if issuers started to use this flexibility it would undoubtedly affect our thinking on their rating”.

In September, the ratings giant issued a report warning that covenant quality had deteriorated across all six sub-risk categories between 2012 and end-June 2014, including change of control, liens, and debt. Sectors in which covenants had weakened fastest included oil and gas and consumer products.

Others argue that looser or more flexible covenants should be no great cause for concern – and are indeed, within reason and constraint, part and parcel of a vibrant market.

“There’s no supporting evidence that you would get a higher default rate just because you have weaker covenants,” said SG’s de Carne. “It’s far more important to look at [a company’s] underlying credit performance.”

If a firm’s income stream is reliant solely on a few key clients – a classic example being Phones4u – the renewal or not of those contracts may be more critical than the details of the covenant package.

Besides, it is a fallacy that investors will snap up any pricey paper going. Europe’s high-yield space, said Thomas Egan, head of leveraged finance syndicate, EMEA, at Barclays, has become a “more self-sustaining asset class, with nearly US$300bn in total notional outstanding in European high-yield” – and more than US$400bn if you include non-investment-grade financials”, offering a range of PIK toggles, dividend plays, and jumbo deals, once the preserve of North American prints.

Slower pace

Investors have become more discerning as a result. Nicolas Jullien, senior fund manager, high-yield and credit arbitrage, at Candriam Investors Group, said the key message for him was to “avoid passive management” and to invest only in corporates with “experience in the high-yield space, and who have been active issuers with a proven ability to weather recent crises”.

Bankers see the market trundling along gently as the year winds to a close. “There are a couple of meaningful deals out there, but the pipeline feels relatively thin,” said one leading syndicate banker. “There may be a flurry of deals in October and November, but the pace has dropped since the first half.”

That, though, is probably no bad thing. Driven by deals big and small, covenant-tight and covenant-light, the high-yield space has proven remarkably adept at regulating itself in a year that is set to be, said Kevin Connell, head of high-yield syndicate at RBS, yet “another record year, surpassing even 2013’s record volumes”.

Next year’s outlook is more occluded, with uncertainty hanging over growth in Europe and Asia, and the unknown impact of higher US interest rates. Barclays’ Egan sees the market remaining “pretty attractive” going into 2015. One thing’s for sure. Whether it winds up proving to be appealing, frothy, contrary, or just a little lumpy, it won’t be boring.

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