Edward Eyerman of Fitch Ratings discusses high
yield’s changing structures and how the asset
class matches up against bank lending as 2014’s
financing tool of choice
High yield may remain a popular asset class, but
fund-raising corporates are still tempted by the loan market.
Based off Libor, loans are callable and easier to recapitalise
quickly as a result. So bond structures are developing to adapt
to the changing demand. Edward Eyerman, head of European high
yield and leveraged finance within the European corporates
department at Fitch Ratings in London explains the challenges
facing the asset class.
What trends are you witnessing? Are covenants changing and
in what way?
We're seeing covenant-lite (cov-lite) in very large
leveraged deals, but they're fewer than the headlines suggest.
We also see covenant loose and more documentation under US
templates as arrangers offer access to US liquidity in addition
to European liquidity. Although it's not a consistent feature
of every deal, we see some European companies issuing dollar
tranches in loans and bonds even though they don't have dollar
revenues and costs – that has been happening since
2012 when absolute yields plus swap costs were lower in the
dollar high yield market than in the European market. In 2013,
the European new issue loan market returned to compete with US
and European high yield. Large financings, such as DE Master
Blenders, Springer and Ceramtech switched from bonds to all
loans, and then from US cov-lite to more European cov-lite,
highlighting that the European market was recovering.
Barring a systemic shock, we expect abundant liquidity from
the US, the return of European CLO 2.0 and recovering bank
appetite to compensate for the expiration of reinvestment
periods on European CLO 1.0.
Northern European banks in particular have recapitalised and
the leverage finance teams in those banks, as well as
traditional leveraged lenders like the Bank of Ireland,
Commerzbank and Unicredit are again embracing leveraged lending
as a risk-adjusted positive ROE line of business. The scarcity
of assets in comparison to the liquidity chasing them
translates into rising leverage, weaker structures and looser
covenants. Borrowers tend to prefer the loan market because
it's cheaper than high yield as it is based off Libor, which
will likely be lower for longer in Europe given the inflation
outlook and the fragility of the periphery. Loans are also
callable and therefore easier to recapitalise quickly. So the
bond market is missing out on the European champions like Ziggo
and DE Master Blenders.
"As long as
default rates are low and the funds flow keeps coming
in, investors have to make a difficult choice"
The issuance quality in the market is deteriorating as it
struggles to keep pace with a rejuvenated loan market. We see
the market having to take riskier instruments, sectors and
geographies. There are growing numbers of peripheral
industries: Italian gaming, Spanish leisure, car parks and auto
suppliers that the loan market won't embrace at the moment. The
high yield market will carry on growing but the issuance
quality is getting weaker.
The last period of exuberance in the market was in the
spring of 2011. Many of the bonds issued during that time, at
notably much higher yields, have either defaulted or since had
their credit qualities deteriorated so the bondholders
effectively assumed the risk burden of the previous
Have you seen the effect of US tapering yet on emerging
Yes. And emerging markets have been more affected by
tapering and the reversal of global liquidity flows. European
high yield has not been subject to that to date. The asset
class appears to be participating within the narrative that
Europe is safer and recovering. While we have this
disinflationary environment, the expectation is that monetary
policy interest rates will remain low. As a result, yield
seeking is still making its way into the asset class and there
are few other places to find it, especially for retail
Fund flows continue to swell into high yield asset managers,
perhaps as an alternative for the emerging markets outflows.
The question then, is why high yield isn't considered a risky
asset class as well? The answer at the moment points to excess
liquidity within Europe and the US. You also have the narrative
that Europe is now safe and corporate credit assets will
participate in the broader developed market recovery. Compared
to US and European investment grade and emerging markets, high
yield benefits from demand for short duration as it is less
sensitive to rises in benchmark rates. Loans of course, have no
duration, and are set to perform well so long as default rates
European leveraged credit appears to be in a sweet spot at
the moment. The only issue is that there aren't enough assets
out there given demand, so the comparative risk-reward
advantage may dissipate quickly.
Are you seeing investor protections being eroded?
Yes, but I'm more concerned about the rise in senior
leverage which will result in lower recoveries for everybody,
than I am about covenants or structural subordination. I am
more worried about the return of high senior leverage because
that simply means there's a greater claim on whatever residual
value there is at default by the senior creditors. We saw what
happened with the subordinated second lien and mezzanine market
insofar as their recoveries were very poor from the 2006 and
2007 vintages, because senior leverages were so high. Better
structures and covenants might have helped, but Europe remains
senior creditor-friendly in terms of jurisdictional rights,
especially with the UK scheme of arrangement as the forum of
choice for distressed restructurings.
Portability became a mark of last year's high yield market.
Do you think it's here to stay this year?
Yes, I think it's a debtors market right now. Again, there
is too much liquidity chasing too few assets. And you don't see
sponsors buying – instead they're selling via IPOs or
strategic sales to global corporates. They don't want
pre-payment penalties and change-of-control provisions to block
their exits. Portability also allows secondary buyouts.
However, valuations in the IPO market and among large
strategics are pricing sponsors out of many deals at the
moment. The only large secondary buyouts we have had are ISTA
and Springer. With more leveraged buyout exits than new issues,
net loan volumes are declining while global loan capital
formation is expanding. Investors will have to tempt sponsors
with higher leverage, looser covenants, tighter pricing and
other debtor-friendly features like portability.
For their part, the sponsors have clearly indicated that in
this valuation environment in core Europe it's better to be a
seller than a buyer, so they're going to Spain and Italy where
there is still a discount. They do not appear eager to overpay
for businesses in the way they did in 2006 and 2007, especially
given their return requirements and when there is very little
growth on the horizon in Europe.
In 2012 there were complaints from the buyside about the
absence of disclosure on high yield deals. Do you think that
The standards have improved a lot from 2012, especially on
issues like voting and enforcement rights, though reporting and
disclosure discrepancies between loans and bonds of the same
debtor remain. Nonetheless, as long as default rates are low
and the funds flow keeps coming in, then investors have to make
a difficult choice: it's hard for them to sit on cash when
their mandate is to invest in high yield. So to make demands
when there aren't enough assets already is difficult. A lot of
these risk factors, although not ignored, are certainly not
What will it take to disrupt this cycle?
I don't know. Low coupons allow a lot of weak, even
highly-levered businesses to carry on, and Europe is supposed
to be fixed and recovering. Generally, it takes some sort of
systemic event related to a market fail to de-rail the asset
class. When that happens, there is a rush for the exit among
holders of risky assets. In 2011, we had the Arab Spring, the
Japanese earthquake and the Portuguese bailout – yet
the new issue and secondary market carried on after brief
blips. You could argue the emerging market situation and the
Ukraine are similar now in 2014. It was only when Greece needed
a second bailout in the summer of 2011, and the prospect of
private sector involvement that sent everyone for the
Of course, it's a lot easier to acquire risky assets than it
is to exit them. Yields and spreads have come down steadily as
confidence in leveraged credit assets improved, but a
significant market fail that raises concern over the system and
the correction will be swift and painful. It may not be as bad
2008 and early 2009 as there is much more depth and diversity
in the market, though losses will indeed occur. Yet without
knowing when that will happen, the structure of investment
complex forces managers to remain invested as long as the music
is still playing.
What are Fitch's priorities for 2014 within high
We had a very good 2013 in terms of our penetration of the
CLO 2.0 market and we hope to consolidate and grow our position
in 2014, which will give us even more exposure to the European
leveraged loan market and global investor platforms. We also
want to consolidate our relationships with investors as a
valued research resource, grow our market coverage of the
indices and highlight companies that access the market with
Fitch + plus one other agency.
Head of European leveraged finance
London, United Kingdom
T: +44 (0)203 530 1359
Edward Eyerman is managing director and head of
European high yield and leveraged finance within the
European corporates department at Fitch Ratings in
London. Ed began his career in 1994 as a sovereign and
financial institutions credit analyst at Merrill Lynch
in New York, where he provided fundamental credit
research and relative value analysis on Yankee bonds.
He moved to London in 1997, where he was an original
member of Deutsche Bank's global markets' credit
research department and subsequently its European high
yield origination team.
From 1998 to 2002, Eyerman worked in the investment
banking division at Credit Suisse First Boston,
principally in the European acquisition and leveraged
finance group. He holds a Bachelor of Arts in History
from Holy Cross College in Worcester, Massachusetts,
and a Masters in International Affairs from Columbia
University's School of International and Public Affairs
in New York.