The European high-yield market is on track for its lowest quarterly volume in three years, as the Russia-Ukraine war intensifies risks associated with inflation, rising interest rates and potential stagflation, putting issuance on pause since the second week of February. Meanwhile, challenging market conditions even prior to the conflict have put a cap on average bond sizes for seasoned issuers, and LBOs have increasingly turned to floating-rate bonds in response to rising inflation expectations.
Speculative-grade European corporate bond issuance so far this year (to March 18), stands at €10.77 billion across 29 deals, according to LCD data, which is the lowest such total on a quarterly basis since the first quarter of 2019, which recorded €9.4 billion of volume.
High-yield issuance in the first part of the quarter was robust, with €7.4 billion and €3.4 billion sold into Europe in January and February, respectively. But the Ukraine crisis has since triggered a long-running blackout — as of March 23, the hiatus since the last benchmark-sized European high-yield bond pricing had reached 41 days, according to LCD data, running close to the 47-day supply gap prompted by the onset of the COVID-19 crisis back in February 2020.
But whereas the COVID-19 crisis sparked a refinancing-driven high-yield bond binge that lasted nearly two years, the spike in bond yields caused by the war in Ukraine is prompting analysts to scale back expectations for issuance this year. J.P. Morgan researchers, for example, in March downgraded their forecasts for corporate non-financial high-yield bond supply to €90 billion for 2022, having predicted annual supply of €140 billion prior to the current geopolitical crisis.
Structural problem
With markets now adjusting to structurally higher inflation — and with most companies already having refinanced into longer maturities and lower coupons in the last two years — it is difficult to identify a catalyst to drive issuance going forward, against such a challenging backdrop. “Following another record issuance year in corporate credit, primary markets are suffering a bout of indigestion,” says David Allen, managing partner and CIO of AlbaCore Capital Group.
Furthermore, softer fundamentals have prompted a weaker response from the buyside. Fresh memories of the sharp rebound from the COVID-19 sell-off in 2020 mean there has been little in the way of panic selling so far, but equally investors have shown a limited desire to put money to work. “ETFs and HY funds… are temporarily on the sidelines raising or holding cash to fund redemptions,” Allen said. “When one or two anchor orders step away from the market, pricing can widen considerably (100-200 bps in some cases) in order to get a deal over the finish line.”
Issue sizes shrink
Even prior to the ratcheting up in tensions between Russia and Ukraine in February, one feature of the difficult market conditions during the first quarter was the tendency for repeat borrowers to target smaller deal sizes. Indeed, while the average deal size for debut borrowers was robust at €474.9 million (to March 18), according to LCD data, the average size for seasoned issuers was much smaller at €324.97 million (down from €532.40 million in the first quarter of 2021).
This size reduction came despite average deal sizes across syndicated loans and high-yield bonds in Europe hitting a record high in 2021, according to LCD. So far this year, there appears to be no blanket trend running through the deals, with multiple factors in play ranging from elevated new-issue premiums to a preference for leveraged loans over high-yield bonds .
Sponsors BC Partners and CPPIB, for example, in January downsized the eight-year unsecured bond offering backing their buyout of Ceramtec to €465 million from €515 million, preferring an upsized €1.48 billion seven-year term loan. By comparison, the 2017 buyout of the German implants group was funded by a €970 million seven-year TLB, a $175 million dollar term loan and a €406 million eight-year unsecured bond.
Other issuers simply opted to refinance into smaller bonds. Spanish travel group eDreams ODIGEO, for example, in January refinanced €425 million of 2023 bonds with a new €375 million 5.5-year bond deal at 5.5%. Instead of an all-debt refinancing, the company chose to issue €75 million in equity to support the repayment of its old bond.
Second fiddle
Another trend was for issuers favour the dollar market. In a transaction which marked the first high-yield offering of the year in Europe, Dutch mobile operator VodafoneZiggo in January priced a €2.1 billion-equivalent, cross-border secured sustainability-linked bond deal across €750 million and $1.525 billion of 10-year notes, which priced to yield 3.5% and 5.125% respectively after a difficult book-building process. More recently, New York-listed can producer Crown Holdings chose the dollar market, raising $500 million with an eight-year bond at 5.25%. That deal marked its first bond since 2019, when the company set a record for the lowest-ever yield in the European high-yield space with a €550 million bond due 2023 which priced at just 0.75%.
With the steep rise in yields on both sides of the Atlantic, bankers do not expect borrowers with both a euro and dollar footprint to opt for the former, with borrowers more likely to choose the deeper pockets of the dollar market as funding conditions tighten. “For the time being we will see potential reverse-Yankee borrowers stick to the U.S. market,” said a banker at a European arranger.
According to LCD data, average yields for single-B and double-B rated credits were 5.27% and 3.02% respectively for the first quarter (to March 18), up from 4.94% and 3.05% in the fourth quarter of 2021. While this is comfortably below the averages recorded in the final three quarters of 2020 for both ratings groups, bankers are expecting this measure to spike once the market reopens. “The speed of the increase has been staggering and it will always take time for issuers to get accustomed to that,” notes one high-yield banker of the rising yields. “A double-B credit pricing with a four-handle, up from a two-handle last year, is not an easy change to digest.”
“Our observation is that the market is two percentage points higher than it was last year,” concurs one bond portfolio manager. “A 2021 issue with a 2% yield would be 4% in the current environment, so the question is who will be the first to lock in that rate as a new standard?”
For drive-by style trades from higher-rated borrowers, there has been resistance to upsizing deals in the face of higher new-issue premiums. For example, Milan-listed construction group Webuild, rated BB-/BB, paid a hefty premium to price a €400 million offering of 4.5-year sustainability-linked notes, which it launched at 3.875% on Jan. 19. A report by S&P Global Ratings which accompanied the transaction signalled an offering of up to €500 million for the debut sustainability-linked offering, with the company clearly put off by the steeper cost of funding.
Similarly, BB/Ba2/BB rated Italian motorway operator Autostrade per l'Italia in January chose not to upsize its six- and 10-year bonds, which it launched at €500 million apiece at yields of 1.734% and 2.359%, respectively. While books were adequately covered at €1 billion and €1.3 billion for each tranche, bankers had told LCD prior to launch that the issuer was targeting up to €750 million per tranche.
Shifting sands
For underwritten deals and private equity-backed refinancings, sponsors were forced to think on their feet to adapt to the changing demand landscape. As LCD data shows, debut borrowers were still able to tap large bond sizes — but several transactions saw wholesale changes during marketing to accommodate higher demand for floating-rate bonds.
“Appetite for floating-rate risk has helped buoy loan market performance this year, and deal-by-deal demand for loans and floating-rate risk has helped drive this,” said AlbaCore's Allen. “There are recent examples of primary deals where fixed-rate securities have been scaled back or eliminated.”
The buyout of Renta Group in January by IK Partners saw a planned €350 million five-year fixed-rate bond switch entirely to FRNs during the book-building process, while ION’s takeover of Cerved was funded by the largest floating-rate bond in four years, according to LCD data. Cerved's FRNs eventually came at €1.05 billion, with the seven-year fixed-rate portion sized at a relatively slim €350 million. Similar moves were seen by United Group and Sazka, with FRN issuance so far at €2.53 billion this quarter, up from only €1.67 billion in the same period in 2021.
While bankers reported pushback from some traditional high-yield accounts and said CLOs were a key driver of demand, there has been a clear shift in investors’ appetite for FRNs, leading to a reassessment of the role of capital appreciation in the asset class. “We think it’s unlikely that the asset class will generate much capital appreciation during 2022, given that the average bond price was hovering above par at year-end,” Oaktree wrote in a quarterly round-up on March 16.
Indeed, floating-rate bonds with fixed pairs clearly outperformed in the first quarter. United Group’s €480 million of E+487.5 FRNs due 2029 were at 97.15/98 on March 23, according to Tradeweb, while its fixed-rate 2030 bonds were well underwater in a 92.5/93.5 context.