European high-yield set to start 2013 with a bang

Fri Dec 14, 2012 5:38am EST

* Active Q1 predicted for primary after strong year-end

* Lending restraints, CLO demise to drive high-yield growth

* LBO prospects still uncertain

By Natalie Harrison

LONDON, Dec 14 (IFR) - European high-yield bond markets are heading into 2013 in tip-top shape with bankers predicting an active first-quarter as issuers take advantage of tight spreads and deep liquidity to refinance maturing leveraged loans.

Strong investor reception to almost USD10bn supply in the fourth-quarter, including deals from debut borrowers such as TMF, Ciech and Rottapharm, has boosted the market's confidence.

"The trends of bank deleveraging and lack of new replacement CLO issuance will again dominate the agenda in 2013. High yield bond markets will therefore continue to increase their importance as an alternative funding source," said Kristian Orssten, head of high-yield and loan capital markets, EMEA at JP Morgan.

As collateralised loan obligations (CLOs) - a large source of credit during the 2006 and 2007 leveraged buyout boom years - near the end of their reinvestment periods in 2014 and regulatory pressure restricts banks' ability to lend, the high-yield market should continue to expand.

Low economic growth, together with expected sub-3% default rates also bodes well for the asset class.

"Of all capital markets, the growth prospects of high-yield means it is the one market that we feel most optimistic about," said Orssten.

European high-yield corporate supply across all currencies totalled USD56.7bn during the year, compared to USD55.1bn in 2011 and USD63.2bn in 2010, according to Thomson Reuters data.

Although the European record set in 2010 remains, volumes were still impressive given a shaky start in January which prompted many European borrowers including Taminco, Polkomtel and Fresenius Medical Care to turn to the resilient U.S. bond market to fund leveraged buyouts and to refinance loans.

In terms of euro-denominated supply, issuers sold USD31.2bn-worth of bonds versus USD28.3bn in 2011 and USD42bn in 2010.

OUTSTANDING CONDITIONS

European high-yield returns topped 20% in Europe in 2012 - far outstripping the near 14% returns in the United States. As underlying yields look set to stay low into 2013, investors will likely be tempted to move further down the credit curve or buy longer-dated bonds.

The breadth of supply over the past couple of months already offers evidence of that. Well-known repeat issuers such as Unitymedia have taken advantage of strong demand to print rare 10-year bonds, while Triple-C rated Payment-In-Kind bonds for Com Hem and Annington Homes prove the market is wide open.

"The market conditions over the past three weeks have been outstanding," said Henrik Johnsson, head of European high-yield capital markets at Deutsche Bank.

"I would expect spreads to continue to grind tighter in Europe if the U.S. fiscal cliff is resolved, and despite the political situation in Italy."

Among other risks is a sharp slowdown in Chinese growth, but absent a major shock, capital markets should remain open for business.

Another expectation is that Europe will play catch-up with the U.S. in terms of spread performance.

There is still plenty of value in the European asset class to compensate for default risk, bankers say, even though the Crossover has tightened to 460bp from more than 750bp in May.

The average spread of high-yield over government bonds is currently at 583bp, according to Bank of America Merrill Lynch data, versus tights of just 241bp in the last cycle.

The spread differential between Double B and Single B credits, meanwhile, is around 257bp.

UNCERTAIN PE EXITS

Leveraged finance bankers are in overall agreement that the bulk of high-yield supply will be dominated by refinancings. About 75% of bonds in 2012 were refinancing related, according to Credit Suisse.

The main supply uncertainty, however, appears to be around new LBO prospects following a dismal year in 2012 as many auctions failed on the back of breakdowns in price negotiations.

However, some bankers are becoming more upbeat that high-yield bonds will play a significant part in buyouts with auctions for book publisher Springer and French caterer Elior amongst the highest profile deals in the running.

"Potential capital commitments are probably at the highest they have been in the second half of this year," said Johnsson.

As an alternative, however, financial sponsors that have been unable to exit their investments will increasingly look at dividend recapitalisations as well as more flexible bond structures like floating rate notes.

Mathew Cestar, head of leveraged finance in EMEA at Credit Suisse, predicted that dividend recapitalisations will become more prevalent in 2013, up from 9% of all supply across leveraged loans and high-yield bonds this year compared to 25% in the U.S. leveraged finance markets.

"Investors' perceptions about recaps are changing. They recognise that there are few IPO opportunities and only selective M&A exits," said Cestar.

"These deals are also different to the last cycle in 2006 and 2007, when recaps were used to take leverage up to very high levels."

Elizabeth Moore, head of acquisition and leveraged finance capital markets at Nomura, agreed that investors were increasingly open to dividend recapitalisations, pointing to deals from the likes of RAC where private owner Carlyle had only taken out about half of its equity investment from the proceeds.

There is also a focus on portability features, which allow bonds to remain in place even when a business is sold, and therefore would help pave the way for an exit further ahead when M&A conditions become more favourable, she said.

"Portability features are not common, but there have been a few transactions that have included them and every bank is considering them now for selective transactions." (Reporting by Natalie Harrison, IFR Markets; Editing by Alex Chambers and Julian Baker)

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