What to expect from European HY structures

Author: Gemma Varriale | Published: 15 Nov 2013
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  • 2013 has already been a record year for high yield in Europe, with new issuance soaring to 78 billion;
  • But there is a growing concern that deal terms are getting too loose;
  • Increased diversity is apparent in capital structures, with high-yield now able to take the place of the no-longer available term loan;
  • To rescue the southern European financial system, it is expected that companies will have to access the high-yield bond market.

The dramatic maturation of European high yield has led to changing realities and, with the market poised for continued growth, there are more changes to come.

New high-yield issuance in Europe soared to €78 billion ($105 billion) over the first 10 months of 2013, already making it a record-breaking year.

Some still question the depth of the market and complain about inadequate disclosures, the introduction of more aggressive terms, and the recent vintage of smaller deals and poor secondary liquidity. But the high-yield market is nevertheless growing rapidly and has attracted record liquidity, both from existing core investors and new entrants.

"Those who follow the European high-yield markets are well aware of the numerous records that have been set so far this year," said Michael Moravec, managing director and head of Barclays’ EMEA leveraged finance team. "The peak issuance pre the 2008 credit crisis was €37 billion in 2007 and, while our market has experienced steady and consistent growth from 2010 to 2012 against many headwinds in Europe, 2013 has really been the breakout year."

Further reading

Are investor protections in European high- yield notes being eroded?

High-yield portability becomes more aggressive

The new WBS options for real-estate companies

Vingroup high-yield bond sets SE Asia PE precedent

Evolution of covenants

Record volumes and different deal structures has spurred growing concern that deal terms are getting too loose.

"In a strong market you do see people getting away with a lot of flexibility, but some of that is simply reflective of the structures that are being put in place," said Michael Dakin, a partner with Clifford Chance.

"It’s helpful that at the same time you do see more conservative deals and more conservative credits coming in," he added, speaking at the Association of Financial Markets in Europe's (Afme's) annual high yield conference in London this week. "Investors have shown that there are some things that are more and more important to them, [...] but we do feel that the market is still in a healthy spot."

Speaking on the same panel, Jocelyn Seitzman, a partner at Latham & Watkins, noted that a key development of the last 12 months has been the re-appearance of issuer-friendly bridge terms.

"We’re seeing a real resurgence of bridge terms that are pre-crisis," Seitzman said. This could be driven by the fact that when the high-yield markets are so hot the investor community knows that the temporary financing is going to happen sooner rather than later, she noted.

This, Seitzman added, means investors don’t have to agonise as much about the security or terms around the bridge, or how they would get out of the bridge if things go wrong.

Diversity

Panellists identified increasing geographical diversity and growth in debut issuers as another key trend. As banks continue to fall under the regulatory spotlight and are less able to lend, companies are increasingly looking to the investment grade and sub-investment grade bond markets as a source of liquidity.

"First time issuers, in many cases smaller and requiring enhanced credit analysis, have helped build diversity and round out the quality profile of the market," Moravec noted.

So far in 2013, 70 new issuers have accessed the market, which is more than the past five years combined. Those 70 issuers have accounted for 37% of new issue supply.

"As there continues to be a global bid for enhanced yield, lower rate credits are contributing to more supply," said Moravec.

Double B credits accounted for €22 billion, or 14% of year over year growth. Single B have accounted for €40.6 billion, which represents 57% year over year growth. Even triple C issuance is up 77% year over year at €8.5 billion.

The trend for increasing diversity also extends to capital structures.

Seitzman noted that the high-yield product is now able to take the place of the term loan, which is no longer available. "It’s effectively become flexible enough to be the senior secured space and sitting alongside a term loan or perhaps a revolving credit facility," she said. "For us what’s exciting is the creativity that’s going on with respect to the ability to slice and dice the capital structure in any number of ways."

"In any of these structures you might have a senior secured bond with high yield covenants, you may have investors and companies looking to issue term loan Bs, or these covenant-like structures," she said. "The question is how do you get all these pieces to fit together."

A changing paradigm

Recent debate has also focussed on Europe’s move toward a more US-style model, where two thirds of corporate borrowing comes from the bond market. In Europe, the figure is one third.

European high-yield from outside London is still dominated by the big US names. But Martin Reeves, Legal & General’s global head of high-yield, noted that the high-yield market is going to look completely different in 10 years, with far more European involvement.

To rescue the southern European financial system and corporate sector, companies will have to access the high yield bond market, he said.

"The governments of those areas within Europe are going to gradually realise this," said Reeves. "That means we actually have certain government authorities who will be massively supportive of the use of high yield."

Further reading

Are investor protections in European high- yield notes being eroded?

High-yield portability becomes more aggressive

The new WBS options for real-estate companies

Vingroup high-yield bond sets SE Asia PE precedent