Activity in the European bond market and syndicated loans should resume in June
European syndicated and high-yield loan markets are expected to rebound after the UK Jubilee long weekend after three months of choppy primary supply. Bankers are hoping a successful reopening in June will kick off a busy summer and allow them to liquidate a large inventory of deals. However, managers’ sense of caution is fragile and the liquidity available for all transactions is far from certain.
“We hear of several deals that may test the general market after the Jubilee holiday, but arrangers will have to be selective in what they bring in,” an official said. A banker at a major arranger agreed, noting that the main question is whether launches and calls from lenders will begin immediately from June 6 or whether underwriters will wait a few days to assess terms.
There is a clear pipeline, and the inventory of signed deals – initially considered light after Russia’s invasion of Ukraine – is now considerably fuller, at over 30 billion euros, according to LCD data. This includes large tickets for Morrison, ekaterra and 888 Assetsas well as a series of smaller – but still voluminous – requirements from borrowers, including Ivirma, Theramex, CSC, Affidea, Accell Group, Wordline TSS, Inetum and Nuuday, among others. “A handful of trades underwritten could be forced into action at any given time,” an official said.
Hopes for a syndication revival come amid a more stable backdrop, for high yield at least, over the past two weeks, with a handful of strong double B trades in bonds and an add-on in loans – a no – fungible agreement from Inspired Education guided at E+475 with a floor at 0% and offered at 96.5-97. Responses are expected on June 8.
In last year’s market, an add-on of this size would have barely received any feedback. But by any measure, May was a weak month for issuance, with volumes of just €420 million in loans and €2.05 billion in high-yield securities. Indeed, 2022 has been a weak issuance year so far, with May’s low high-yield issuances topping all monthly totals since February, when the market handled €3.42 billion in volume. In lending, monthly totals in May and March of this year were as paltry as every month since 2009 (excluding the traditionally slow months of August and December).
The low volume was accompanied by high volatility in the secondary markets, with loans in particular underperforming. “Volatility has discouraged the buyer base [in loans] and CLO supply has evaporated,” one banker said, adding “we don’t see support from SMAs and other non-CLO funds.” The average supply on the S&P European Leveraged Loan Index ( ELLI) fell to 94.12 on May 27, the lowest since August 2020, when the market found footing after the pandemic began.Before Covid-19, the index had not recorded levels as close to 94 since the fall of 2013. ELLI returns also fell to -2.58% in May, from a -3.24% year-to-date return.
The lending weakness is a reversal from early last year, when high yield fell faster and deeper. This change reflects the shift from a market that is hypersensitive to rates to one that is increasingly trading on fears of recession. “Loans are good as non-duration products, but they still offer below investment-grade risk in a risk-averse market,” one manager said. “They are not the paradise we hoped they would be at the start of the year,” he added.
For bond investors, tracking a weakened economy initially meant energy-intensive credits exposed to price increases following the Russian invasion, before moving on to other credits exposed to inflationary pressures and consumer-oriented securities. High yield volatility has increased. The average bid in the iTraxx Crossover has seen wild intraday swings to deviate from 500 on some days. “There is still uncertainty everywhere,” an official said. Investors add that duration remains a concern, but with high yield generally down around eight points on the year, firmer rate expectations in the US and Europe are now priced in. Managers attribute about half of this year’s loss to high yield over duration, with the rest related to credit issues, suggesting there is now some fair value with lending. “There is liquidity in bonds in Europe but the attitude is still risk free,” said one manager.
So where does the market go from here? Of course, few expect a turnaround anytime soon. “It’s not going to be a quick recovery,” said a manager. “Central banks are not about to come to the rescue and start providing liquidity like they did in 2020,” he added. Others point out that downside risks persist. “If you think a recession is coming, it’s inevitable that markets will continue to fall from here,” another manager said.
That said, there are structural features in favor of leveraged finance in Europe. On the one hand, there is little refinancing pressure after benign conditions over the past few years have allowed issuers to extend maturities to highly advantageous levels. There are, however, tough decisions for the remaining names in difficult sectors facing a need to mature over the next year. Last week, for example, S&P Global Ratings downgraded UK retailer Holland & Barrett to CCC+ while noting, among other things, low liquidity and the company’s impending revolver maturity, due August 2023. Despite this and a few other key situations, the European market’s need for refinancing n will reach its maximum only in 2026-2028.
The documents are also loose and give sponsors a lot of leeway to resolve issues. But the repricing in corporate credit still reflects a shift in default expectations that most believe are on the rise. “The market is now pricing a default rate towards 3% vs. 1% previously,” one account said. The change is in line with market watchers such as S&P Global Ratings, which forecast a 12-month European speculative-grade default rate of 3% by March 2023, down from 0.7% in March this year, in a note. released May 18. 3% rate would result from 24 business failures by March 2023.
But there’s always cash to invest in the right deal, even if there isn’t complete agreement on what the deal looks like. “There is a price to be cleared, but it is much more difficult to structure the right transaction acceptable to the market”, explains an official. “The market has changed, but it is unclear where the new paradigm is,” added a banker of a major underwriter. In high yield, there was demand over supply for strong names in double B such as ELIS and Volvo Car in May, although this has only limited reading for the type of single-B names that form the core of the sub-investment grade market – and in particular loans – in Europe.
For loans, pricing expectations have changed since Refresco completed its €3.4 billion cross-border buyout in early May, which included a €1.53 billion term loan priced at E+425 with a floor of 0%. This deal has since drifted in the secondary towards the 97 support, from a fresh offer of 99, suggesting a rough yield at 4.95%.
For new deals, some large corporate executives are placing their new global pricing requirements for simple decent B credits closer to E + 500-550 basis points for plus OID loans, or 6.5-7.0% for the obligations. “The marginal euro is going to be the most expensive part of the deal,” a source said. Tougher credit stories will be an even tougher sell, with OID talks of the €515m Optigroup E+525 buyout loan reportedly hitting 91, down from 95 before syndication was paused at mid-May.
The overall debt capacity has also not been tested with a doubt as to whether the single European market B could reach the 3 billion euros of loans let alone that figure of bonds considered possible until the end of last year. “All currently subscribed transactions will not be canceled,” summarized an official. “But the market will adapt and provide structures suitable for today’s conditions,” he added.
On the demand side of the equation, liability spreads are an obvious stumbling block for future CLO issuance, having widened further in recent weeks. That said, as of 31 May, the volume of new European CLO issues for the year, at €13.39 billion, exceeded the €12.48 billion of new issues recorded during the same period in 2021, which ended a record year.
At the start of 2022, most research bureaus estimated that new issuance for the full year would be slightly lower than in 2021, but the issuance picture is now clearly mired in macroeconomic uncertainty, analysts from the market having already lowered expectations since the invasion of Ukraine. .
The bulk of the €38.6 billion in 2021 new issue volume during the second half of last year, when triple-A coupons ranged from 94 basis points to 105 basis points (excluding static CLOs) and the weighted average cost of capital (WACC) on transactions ranged from 175 basis points to 213 basis points (excluding transactions without simple B tranches), according to LCD.
The last two CLOs to be cleared by the market had triple-A coupons of at least 120 basis points, and the secondary levels moved much further, the sources say. In a research note published on May 27, Deutsche Bank analysts wrote that secondary triple-A spreads had widened to “about 160 basis points.” A similar broadening has occurred across the capital stack, pushing WACC over the last two draws to 236bps (May 16) and 263bps (May 24).
At these levels, the CLO new issuance pipeline is currently uncertain and resets remain irrelevant. However, conditions in the European secondary loan market have recently created a sufficient window for a print-and-sprint, a CLO without a pre-pricing warehouse in which managers go entirely (or almost entirely) into the secondary market. Conditions have remained soft since the Carlyle Euro CLO 2022-3 was priced at €337.7 million on May 24, with the S&P European Leveraged Loan Index (ELLI) closing at 94.16 on May 30.
However, the window for such trades is usually short and depends on the manager’s ability to carve out a path for triple-A ratings and its ability to generate sufficiently attractive stock returns, a daunting task in this environment.
Nonetheless, a potential reopening of primary loans in June is good news for booming warehouses, including those that postponed transactions in late March, given the opportunity to source assets at new global prices.