* Euro corporate bond market gears up for bumper H2
* More hybrid deals expected
* M&A borrowers face leverage risks
By Laura Benitez
August 8 (IFR) - The European corporate bond market is expected to reload early after the summer break and is gearing up for a bumper second half of the year as issuers keen to refinance M&A bridge loans prepare to tap the market.
Debt capital markets bankers have been hoping for some time for a pick-up in M&A activity to bolster primary bond market volumes and it looks as if their hopes are finally coming true in 2014.
According to Thomson Reuters data, year-to-date global M&A activity totals US$2.2trn, up 66% from the same period last year, while July’s total of US$428.5bn is the highest monthly level since 2007.
“We’re going to see more activity in the European investment bond market coming from the increase in M&A financing; it’s definitely shaping up to be a busy September,” said a syndicate banker, who added that the market had plenty of capacity to absorb extra supply.
A head of syndicate echoed this view, adding that he was working on eight upcoming M&A-related bond issues. There is currently 63.2bn worth of European bridge loans due to mature before the end of 2015, while European leveraged syndicated volume year to date stands at 85.5bn, according to Thomson Reuters data.
Increased M&A activity partly stems from the wave of so-called tax inversion driven deals that have flooded the M&A market over recent months. Companies have been eagerly approaching targets ahead of new US tax rules that are expected to come into play on January 1 2015.
The rules will restrict companies from inverting: a method where businesses are restructured abroad to adopt new tax jurisdictions for 20% of the combined entity’s stock.
“It makes sense for those US companies that have global operations and a mid-level investment grade and European profile, and those with chunky funding size requirements to target European investors. Some of these deals will be as large as US$20bn, while others are much smaller at US$5bn,” the head of syndicate said.
The European corporate bond market has so far coped well with an increase in supply and volumes year to date are ahead of last year‘s, at more than 169.8bn-equivalent compared to the 140.1bn according to Thomson Reuters data.
Corporates are expected to use every available tool in the treasurer’s tool box, with hybrids making up an important part of the financing mix, according to market participants.
Already, the volume of hybrid bonds issued so far this year totals more than 27bn-equivalent, compared to 25.4bn- equivalent in the same period last year, according to Thomson Reuters data.
One syndicate banker said the corporate bond market is undergoing a change in dynamic, in which subordinated and hybrid deals are becoming a standardised product with more intraday-executed transactions being seen.
“It’s changed the landscape for hybrid deals. We’ll be seeing low-beta names issuing these deals in the near future, and they will attract investors chasing bigger yields and more flexible tenors and ratings,” he said.
Meanwhile, dual-tranche deals, especially from the bigger names that have been spurred on by increased risk appetite, are also expected.
However, while the market appears to be firing on all cylinders, the increase in M&A is not without risks.
“While the overall leverage ratios remain in check, the size of deals and consequent aggregate borrowing has been increasing, and this is a trend that we expect to see continue,” said analysts at Henderson.
“Borrowers are also being more innovative in how they use debt to fund deals, with the use of term loans to pre-finance smaller deals entirely rather than requiring costly bridge loans, while on larger deals we see far more use of bond deals with tranches across multiple currencies.”
In a note published at the end of July, S&P warned that while acquisitions in this cycle had been generally supportive for credit quality, rising leverage levels could change this feature of the M&A rebound in Europe.
Meanwhile, a number of corporates have either already been downgraded or put on negative outlook. Fitch downgraded Vodafone to BBB+ from A- in early August, citing the increase in leverage resulting from the acquisition of 100% of the share capital of ONO.
GlaxoSmithKline is another example of a corporate being hit by a downgrade because of M&A. The issuer’s A1 Moody’s rating was moved to A2 in early August, partly because of the “material contingent liability arising from a put option granted to Novartis as part of a three-leg M&A transaction signed earlier this year,” the agency said in a statement.
British Sky Broadcasting Group’s BBB+ Fitch rating could be cut by two notches if its acquisition of 100% of Sky Italia and a 57.4% stake in Sky Deutschland from 21st Century Fox goes ahead. (Reporting By Laura Benitez, Editing by Helene Durand and Philip Wright)