A new decade starts with optimism and a strong pipeline, to build on the resilience of an ever-maturing market.
As we enter the new decade, the resilient European leveraged finance market continues to grow and mature. The market is agile and has continued to deal with significant changes, ranging from the mix of leveraged loans and high yield bonds to the impact of direct lenders, sectoral and regional changes, as well as politics across Europe, including considerations relating to Brexit.
Against that backdrop, we begin 2020 with a pipeline of approximately €36 billion, nearly 70 per cent higher than 2019, year-on-year. Pricing is at an attractive level for borrowers, with the lowest high yield bond pricing levels for new issues in recent times; cov-lite has taken hold of the market; restructurings are at low levels; and a platform for social change, led by the UN Sustainable Development Goals, environmental, social and governance standards and investor sentiment, all point towards great market potential.
These trends are also penetrating more sectors, regions and deal types, as several countries see ‘deal firsts’ as trends flow across borders, and leveraged finance processes support alternative deal structures from traditional LBOs, to move into, for instance, the public-to-private space, with increasing pace.
Still, potential bumps in the road—central bank action causing interest rate hikes, the impact of the coronavirus outbreak (both in China and globally), full details of Brexit and the finalisation of trade deals across the globe—will all have details which will affect the market, but the market is better placed than ever to deal with these factors, as industry professionals put to work their experience of recent years in growing the market to good effect.
Selected European leveraged loan and high yield bond markets by volume and value
The Spanish leveraged finance market went from strength-to strength in 2019, with a selection of large deals and the market’s capacity to execute complex deal structures pushing issuance to four-year highs.
High yield offered few surprises in 2019, but the leveraged finance market in Spain has enjoyed a particularly good year, boosted by several larger deals and significant activity in the mid-market, which is the biggest market in the country. The market has matured, grown
more sophisticated and, as far as investors are concerned, is more closely aligned with Western European trends than ever before.
By the end of 2019, Spanish leveraged finance issuance (loans and high yield) totalled €27.7 billion across 64 deals. This was well ahead of the €15.7 billion issued during all of 2018 and the €20.7 billion of issuance in 2017.
Maturity matters
The market’s maturity is evidenced by pricing in Spain, where spreads have narrowed. In 2014, institutional Spanish loans were priced at 389 basis points (bps) versus 424 bps in the UK, 410 bps in France and 416 bps in Germany, according to Debtwire Par data. In 2019, Spanish loans were pricing at 342 bps on average, versus 381 bps in the UK, 407 bps in France and 396 bps in Germany.
The growth of Spain’s market is further reflected in the big-ticket deals the market has been able to digest and deliver.
KKR’s €602.23 million (US$667.5 million) take-private of pizza group Telepizza, for example, saw the investment firm start out with a standard bridge loan and revolving credit facility, with a view to refinance the whole facility through a €333.8 million (US$370 million) high yield bond priced at 6.25 per cent, according to Debtwire Par.
This deal was particularly notable in that the bridge loan was subject to English law, while the covenant package was subject to New York law. A few years ago, the Spanish market would have found it difficult to understand a complex structure like this. In today’s more sophisticated market, deals like these are no longer unusual.
Grifols is another prime example: The pharmaceuticals group secured a refinancing involving a term loan B (TLB) that sat alongside a high yield bond and a super-senior revolving credit facility. Spanish telecoms group MásMóvil, meanwhile, sought to refinance a convertible bond and simultaneously increase its debt in 2019 by combining a covenantlite loan with the issue of preferred equity.
While TLB structures were considered better suited to London and New York a few years ago, they are now viewed as another viable source of financing by banks and borrowers in Spain.
Spain enters new territory
Deal momentum is expected to carry the market in 2020, with airline operator IAG’s €1 billion (US$1.11 billion) acquisition of Air Europa and a bidding war for Spanish Stock Exchange group BME both expected to tap into leveraged markets.
Despite the positive outlook and cov-lite characteristics of loan issuance, however, an uptick in restructuring activity is anticipated. Deals like the €1.8 billion (US$2 billion) issue for supermarket cooperative Eroski have already made a telling contribution to restructuring values. With the Spanish Socialist Workers’ Party winning the most seats in the November 2019 general election, rising taxes are also a distinct possibility and could weigh on both consumer spending and corporate cash flows
While acquisitions are in the pipeline, the market may see more restructurings by Q3 and Q4 2020, running in parallel with acquisitions. This is new territory for Spain, and should make for an interesting year ahead.
"The leveraged finance market in Spain has enjoyed a particularly good year, boosted by several larger deals and significant activity in the mid-market, which is the biggest market in the country."
In a market that has seen notable highs and lows since the financial crisis, while remaining ever-vigilant for red flags, a degree of consistency is beginning to take hold in European leveraged finance
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HEADLINES
As Europe's leveraged finance market has matured and filled the space vacated by banks following the financial crisis, investors have broken free of sector silos and embraced a much broader spread of industries.
Pre-crisis, the European high yield market was focused primarily on telecoms and other fast-growing industries. It has since become far more diverse. This was already evident in the US, where the market had broadened beyond the traditional group of high-growth issuers.
Issuance figures for European high yield and leveraged loans in 2019 show that no individual sector accounted for more than 23 per cent of the market, and that none of the 10 most active sectors accounted for less than 4 per cent. Leveraged finance has become a broad church when it comes to diversification by industry.
20%
The proportion of leveraged loan activity in Europe issued in the industrials and chemicals sector, in aggregate
loans and high yield bonds In broad terms, industrials and chemicals in Europe have been most active for issuance in both the leveraged loan and high yield bond spaces. According to Debtwire Par data, industrials and chemicals combined accounted for the largest share of activity in loans (20 per cent) and high yield bonds (22 per cent).
This, however, is where the similarities end, with issuance diverging by sector between leveraged loans and high yield bonds.
In leveraged loans, pharma, medical and biotech issuers were the second most active, accounting for 14 per cent of deals, but only 3 per cent of high yield issuance. There is a similar imbalance in the financial services sector, which made up only 5 per cent of European leveraged loan issuance in 2019, but 16 per cent of high yield bond activity.
The types of borrowers active in these sectors have coloured issuance numbers. Private equity firms, for example, are active in the services space and have recently demonstrated a preference for loans, as illustrated by 2019 figures showing buyouts as the secondlargest source of loan issuance at €39.2 billion (behind refinancings/ repricing at €87.7 billion).
In high yield bonds, however, services is only the third-largest sector by issuance (5.1 per cent), and LBO takings of €5.6 billion are less than 15 per cent of the €51.1 billion raised for refinancing.
The predominance of chemicals/ industrials as well as financial services for 2019 issuances may reflect the softer high yield market earlier in 2019, with issuers that are more 'sure bets' coming to market and those that are either new to the space or in possession of other financing options taking a different route.
Both leveraged loan and high yield bond investors in general have made an obvious shift to focus on credit quality. Sectors that are under particular pressure, such as automotive and consumer retail, accounted for only 4.4 per cent and 6.8 per cent of deal activity, respectively, in the European loan space in 2019. In the high yield bond market, consumer retail made a small appearance with 2.8 per cent, while automotive only represented a 6.9 per cent share of deals.
The focus is now very much on the business model. Lenders are taking a closer look at the fundamentals of a business and its sector than they did just a year or two ago.
Sector is also influential when it comes to terms. Historically, the market has been sympathetic to the relaxation of certain terms for companies in specific industries. For example, chemical companies as well as oil & gas operators have been given wide flexibility to invest in joint ventures without further controls, given that this is how the companies have tended to operate their businesses.
The market has also been sensitive to credit-specific points applicable to certain sectors (for example, issuers in the debt purchase and servicing space typically have had tighter controls on securitisations, although that has loosened for certain names in their subsequent issuances).
However, companies returning to the leveraged finance market from sectors where there have been quirks in covenant packages in the past may find that investors are looking very closely at terms and asking whether they still make sense, or whether they could create too much flexibility for the issuer in a downturn.
It is almost certain that operators in distressed sectors (such as retail) will need to tighten covenant packages if they are coming back to market, although businesses in more resilient areas, such as software-as-a-service, will have an easier process.
Some sector borrowers, especially those under pressure and seeking favourable terms, may discover that they must do their homework if they want to attract willing lenders in the months ahead.
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European leveraged debt in focus (PDF)
European leveraged loan issuance by industry subsector—pro rata vs. institutional (PDF)