The market sell-off in late November sparked by the omicron variant of COVID-19 might have put off a few potential suitors that were looking to issue opportunistic high-yield bonds heading into the year-end break, but it proved merely a footnote to an otherwise stellar year for both issuance and returns in this asset class.

Primary markets may have closed earlier than in 2020, but the lackluster finish to 2021 still left European high-yield supply at a staggering €125 billion, which is 33% ahead of the previous record set in 2017 and 47% ahead of the €85 billion tally notched up in 2020.

High-yield bonds sold into Europe in the fourth quarter, to Dec. 10, totaled €27.6 billion, roughly in line with the fourth quarters of 2020 and 2019, which both hosted just over €26 billion of supply. This latest total is also ahead of the €23.2 billion five-year average for fourth-quarter issuance, according to LCD data.

October, all over

While this fourth-quarter volume was not out of the ordinary, issuance in October was particularly striking, as the European bond supply breached the €15 billion monthly threshold for only the second time since LCD started tracking this data, thanks to a deluge of M&A and leveraged buyout financings. The mark was first exceeded in June, when the monthly volume reached €17.1 billion.

M&A and leveraged buyout activity was in play all year, with the COVID-19 shutdown having stalled deal-making globally, leaving a huge deal pipeline heading into 2021. But it was not until the fourth quarter that this dynamic really began to reshape the bond market, with acquisition-related financings contributing an astonishing €15.5 billion of the quarterly tally. This represents well over half the total issuance in that period and easily sets a quarterly record for European bonds to fund M&A and buyouts. The two closest comparisons were also in 2021, with the first and second quarters producing €8.6 billion and €12.7 billion of M&A-related bonds, respectively.

It was also a record-breaking year for sponsor-backed supply, with €50.5 billion of such issuance recorded — well ahead of the €23.6 billion and €18.15 billion notched up in 2020 and 2019, respectively, and making up 40% of the total high-yield bond volume. This same percentage split was also recorded in 2012; however, that equated to merely €14.5 billion of volume on this measure.

The LBO surge, which has mostly been dominated by mid-sized deals rather than big-ticket buyouts, reshaped the ratings characteristics of Europe's high-yield bond market. With the exception of the first quarter, single-B rated bonds dominated every quarter in 2021, with issuance in this cohort peaking at €21 billion in the second quarter. In the year to Dec. 10, this ratings category made up 46% of high-yield issuance — the first time since 2018 that single-B credits accounted for a greater proportion of total volume than double-Bs.

Challenging times

This deluge of challenging credits arrived against the most prolonged difficult backdrop for European high-yield since the start of the pandemic, with one leveraged finance head reporting a "market diversion" between bonds and leveraged loans. The former asset class experienced the full brunt of rising interest rates and re-opening bottlenecks which loomed over the fourth quarter, whereas strong CLO demand protected leveraged loans from the worst of the volatility and gave rise to a series of opportunistic transactions.

It was not until the emergence of the omicron variant that volatility rose to a level high enough for deals to be pulled, however, and even as sponsors tended to leave little on the table in terms of pricing, most LBO financings passed without a hitch. Deteriorating sentiment in some instances forced pricing wider, as was the case with bonds backing Brookfield's buyout of Modulaire Investments BV, but the consistent trend throughout the fourth quarter was that LBO financings performed weakly on the break into the secondary market, reaffirming the buyside consensus that pricing was aggressive. This pricing strategy clearly helped lower-rated credits though, with average single-B yields remaining below 5% throughout the fourth quarter, according to LCD, which is below the 5.58% average for this ratings category in the fourth quarter of 2020.

When deals were forced to delay at the end of November, Apollo-backed Italian packaging group Reno De Medici S.p.A., rated B/B2/B+, still managed to pull off a €445 million offering of five-year floating-rate notes, albeit at the wide end of initial price thoughts and with a larger original issue discount. This was achieved despite investor concerns relating to the borrower's sector, the sponsor and the steep 9x leverage, as well as a significant price correction during book-building which triggered a repositioning of some investors into double-Bs.

On the defensive
While single-Bs dominated the fourth-quarter volume overall, the trend was most noticeable in October, with only Biogroup, Kem One SAS and Reno de Medici selling single-B rated bonds for M&A funding in November. It was a similar pattern in December, though T-Mobile Netherlands B.V. finally emerged from the well-telegraphed buyout pipeline, raising €1.35 billion in secured and unsecured bonds that clearly benefited from scarcity value as both tranches rose on the break, with the €550 million of eight-year unsecured notes rising quickly above 101. U.K.-based grocer Morrisons however turned out to be the largest casualty of the omicron variant market jitters and weaker backdrop for sterling issuance, with banks in early December deciding to postpone the £5.4 billion bond and loan financing backing CD&R's takeover of the supermarket group.

For much of November and December then, higher-rated borrowers became the focus of investors' attention as higher premiums in the primary market prompted portfolio managers to increase their participation in new deals and reposition into double-Bs after the LBO deluge in October.

For these more rate-sensitive issuers in the double-B category, looming rate increases provided a clear impetus to come to market, despite new-issue premiums remaining elevated even for seasoned credits.

Prior to October, double-Bs lagged lower-rated credits, and in the fourth quarter, average new-issue yields in the double-B space climbed above 3% for the first time in 2021, according to LCD data. For example, French car-maker Renault SA, which is rated BB+/Ba2, paid 2.5% for a €500 million long-five-year unsecured note in November, which is the same interest rate the company achieved for seven-year paper issued in March.

Rate window
"It was a question of finding the right window," said a banker back in November. "Accounts will focus on the deals that give them more alpha, so LBOs will always garner the most attention versus run-of-the-mill double-Bs."

While funding conditions were far from the highs of the first and second quarters, bankers reported corporate issuers expressing regret at missing the September sweet spot as sentiment soared heading into October. With much of the committed pipeline of LBOs having come to market by the end of October, this provided a clear window for double-B-rated companies. While borrowers such as Graphic Packaging and Faurecia issued bonds for widely anticipated M&A financings, for the majority in this ratings bracket, the decision to issue looked entirely opportunistic — and reflected anxiety about rising rates.

This was clearly the case for Paris-listed electrical supplies company Rexel SA, rated BB/Ba2, which chose to refinance its 2026 bonds, not callable until 2023, via the make-whole call provision at 50 basis points over Bunds, pricing €600 million of 10-year notes at 2.125%.

For investors, the market backdrop also made double-Bs an obvious buy, and many of the fallen angel issuers to appear in the fourth quarter — such as Lufthansa, Renault, Accor and Teva Pharmaceutical Industries Ltd. — were the beneficiaries of investment-grade accounts filling their high-yield allocations before year-end. For high-yield accounts, the rationale stemmed from the fact that double-Bs outperformed lower-rated bonds in October, and buyers were overweight single-Bs going into November.

"While so far this year [single] Bs have delivered 5.1% of excess returns versus 3.4% in BBs, nearly all the outperformance took place in the first half of the year," wrote Morgan Stanley analysts in the bank's 2022 European credit outlook. "Returns since the summer have been broadly comparable across the two ratings cohorts."