Despite risks on the horizon, notably a projected increase in defaults in 2012-2013, the European leveraged finance market is emerging from recession, according to a report by Standard & Poor’s (S&P), ‘The High-Yield Bond Market Becomes More Ingrained in Europe, But Risks Remain’. What’s more, the market is stabilising: mergers and acquisitions (M&As) are starting to return and speculative-grade companies in the region are becoming more accustomed to higher levels of public disclosure.
Europe’s high-yield bond market had a record year in 2010 (€44.4bn in issuance versus €24.5bn in 2009), and S&P believes that issuance should continue to grow this year and beyond. Refinancing needs drove the majority (71%) of high-yield bond activity last year (as opposed to M&A-driven financings – 12%), and will likely remain uppermost in the minds of speculative-grade issuers -that is, those with long-term corporate credit ratings of BB+ and below.
Looking beyond 2011, S&P believes that refinancing risk for highly indebted European corporate borrowers could potentially generate a second wave of defaults in 2012 and 2013; leveraged debt maturities peak in 2014 and 2015, with maturities of almost €100bn in each of those years. S&P sees two main reasons for this – a potential lack of funding available to enable the rollover of debt on a timely basis, and the weak credit characteristics of a significant number of leveraged buyout companies that it monitors.
On the positive side, S&P thinks that corporate borrowers, as well as private equity firms, are becoming more comfortable with using the bond market as an alternate financing tool and to reduce their reliance on bank debt. For example, last month, Premier Foods announced its intention to issue a debut bond in 2011 to diversify its funding sources away from banks. In addition, in January, two private equity firms used innovative all-bond financings to make acquisitions – PAI Partners bought ground-handling airport services firm Swissport International and Advent International bought Crown Newco – which allowed the sponsors to use a lower percentage of equity to fund the transactions. S&P believes these issues are significant, because previously, the speculative-grade bond market was not considered to be a reliable way to raise capital in Europe.
While S&P observes that the high-yield bond market is becoming more ingrained in Europe, pricing continues to fall for borrowers, fuelled by excess demand from credit funds. In the recent ‘seller’s market’ for credit in the US, the ratings agency has seen a return to more aggressive financial policies, primarily by speculative-grade issuers.
These policies have most notably taken the form of dividend recapitalisations (recaps). Although S&P has seen this happening to only a limited extent in Europe (four dividend recaps in 2010), it’s something that it monitors because it can signal an increase in borrowers’ financial risk appetite.
In S&P’s opinion, recaps for less cash-generative companies would typically have a negative effect on credit quality, raising the risk of an increase in the future rate of default.
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