US opens up to European risk

European high-yield names have had a clear run at the US capital markets during 2012, taking advantage of the search for yield pick-up among US investors such as bond funds, insurance companies, pension funds and hedge funds. With both retail and institutional money being allocated to funds, they have steady inflows of cash that needs to be invested. Meanwhile, investors such as insurers and pension funds have moved down from the lower reaches of investment grade into BB rated territory in order to generate some additional yield for their portfolios. And for low ’B’ rated names there has also been strong buying from hedge funds.

Most issuance is in the five- to 10-year segment of the curve, allowing corporates to put in place large amounts of medium-term finance at low rates, and strengthen their balance sheets. Many have been moving away from bank loans, given the deleveraging at banks across Europe, and are instead raising bond financing with flexible covenants.

Some have a natural need for US dollars, but others are pure euro businesses, such as European cable TV operators, and have been accessing the dollar market and swapping back into euros. And for some companies, the sheer size of their funding requirements tests the limits of the European bond market, so they have been launching dual-tranche deals.

US issuers quiet

In spite of the sizable global high-yield issuance volume there have been very few signs of saturation on the part of investors, and the technicals continue to favour borrowers.

"M&A [merger and acquisition] and LBO [leveraged buyout] activity in the US has been slow during 2012, and a lot of issuance from US corporates has been refinancing activity, with existing bonds redeemed as new bonds are sold," explains Richard Zogheb, co-head of capital markets origination at Citi in New York. "So in spite of the high volume of issuance from US corporates, cash positions have still been growing at many high-yield investors, and they have been looking for new places to put their money to work."

He says some institutional investors have amended their charters to allow for more investments in non-US corporates, and market conditions have been very positive for European companies in sectors such as cable TV, packaging and chemicals, which are well understood by US high-yield investors." says Mr Zogheb. Some of these issuers want dollar funding, while others are swapping back into euros or UK sterling, often deciding a few days before a deal is launched in which market they can get best execution.

"Traditional high-yield investors such as mutual funds, insurance companies and pension funds are all having to look for additional yield in an environment with historically low credit spreads, and have significant cash positions that they are putting to work in the global high-yield market, so we have had an exceptionally busy year bringing both US and European issuers to the high-yield market," says Lex Malas, New York-based co-head of leveraged and acquisition finance, North America, at HSBC, which has acted as bookrunner on deals including Continental, Virgin Media and Schaeffler.

"At one point we saw 15 consecutive weeks of inflows into high-yield mutual funds, and as of early October there were $24bn inflows for the year," says Mr Malas. "Couple that with fact that two-thirds of financings done in the high-yield market have been refinancings, including refinancing bank debt and new bonds taking out existing bonds, and the technicals are very strong for issuers to access the market and source long-term capital."

Debut issuers

Tanneguy de Carne, head of non-investment grade capital markets at Société Générale in London, says many European names have been issuing for the first time in the US market during 2012, and most of them have prepared the way with non-deal roadshows in order to introduce themselves to investors, as well as deal specific roadshows.

In June 2011 Société Générale committed bank loan and bridge financing for the acquisition of Polish mobile phone company Polkomtel, alongside Deutsche Bank, Crédit Agricole Corporate and Investment Bank and Royal Bank of Scotland. The same four banks then worked on a high-yield bond offering.

In early January, the Polkomtel management team went on a five-day US roadshow taking in New York, Boston and the country's west coast, followed by a three-day European roadshow in London, Paris and Frankfurt. This paved the way for a successful two-tranche, €542.5m and $500m senior unsecured bond offering. The US dollar tranche had an 11.625% coupon, and was priced at 98.1 to yield 12%. Polkomtel is rated B.

Leading Spanish cable operator ONO did a non-deal roadshow in November 2011 to introduce itself, and was able to access the market twice this year, with a $1bn offering in January followed by a $310m deal in May. Joint bookrunners on the second deal were Bank of America-Merrill Lynch, Crédit Agricole, Deutsche Bank, BNP Paribas, JPMorgan and Société Générale.

Stable demand

"US investors have been looking for additional yield and some diversification, and European issuers willing to offer an adequate return are finding that the deeper US market has more stable demand, where you can price continuously, than is the case in the European high-yield market," says Mr de Carne.

If the eurozone crisis is at the top of the news, then US demand can drop off somewhat, but it comes back quickly for well-known European corporates or new names with a good story to tell.

"Repeat issuers such as Rexel, Continental and UPC have taken advantage of strong demand to lengthen the maturity of their debt across various currencies, and companies are also replacing loans with bonds, which typically have longer maturities and more flexible covenants," says Arnaud Tresca, head of high-yield capital markets at BNP Paribas in London. "And with a lot of liquidity in the market, we have also seen a lot of new names from Europe issuing this year."    

In February, Schaeffler, a German company which makes high-precision products including supplying the automotive and aerospace industries, was able to access the high-yield market to refinance part of its bank debt. Management went on a global roadshow on both sides of the Atlantic, and introduced themselves to new investors. The offering was led by BNP Paribas, Deutsche Bank, HSBC and JPMorgan. Schaeffler priced two tranches of dollar bonds totalling $1.1bn and two euro tranches totalling €1.2bn. The five-year dollar tranche carries a 7.75% coupon, with the seven-year tranche paying 8.5%.

"Yields on investment-grade corporates have become extremely tight, so we have seen increased allocations from bond funds into high yield, backed by both retail and institutional money," says Mr Tresca.

He notes that even a small shift of 1% or 2% by large investors such as insurance companies and pension funds represents a sizable increase in allocations to the high-yield asset class, given its small size relative to the investment-grade bond asset class.

High-grade tightening

Despite ongoing volatility due to concerns about the European sovereign debt crisis, US dollar spreads for investment-grade European issuers have continued to tighten this year. Spreads on investment-grade debt reached lows for the year in October according to Melissa Smith, head of high-grade debt capital markets for Europe, the Middle East and Africa (EMEA) at JPMorgan in London.

"There is not much depth of demand at the long end of the curve in euros, so being able to access 30-year maturities in the US market is another motivating factor for investment-grade European issuers to issue in US dollars," says Ms Smith. "This year we have seen strong demand from US asset managers, insurance companies and pension funds for high-grade paper, with insurers and pension funds buying more of the longer dated tranches."

In October, JPMorgan was joint bookrunner on a $3.25bn offering from Baa1/BBB+ rated Heineken, across three-, five-, 10- and 30-year tranches. This was the largest ever bond deal launched by the Dutch brewer in any currency. The proceeds are being used for the acquisition of Asia Pacific Breweries. The five-year bonds carry a 1.4% coupon, and were launched at 85 basis points (bps) wide of US Treasuries, while the 10-year bonds pay 2.75%, with a launch spread of Treasuries plus 115bps.

Five to 10 years is precisely the area of the yield curve where investment-grade buyers can find a plentiful supply of high-yield paper, often in comparable industry sectors, and the trend for investors to go down to BB to pick up extra yield looks set to continue. The supply of BB rated paper is likely to increase in 2013 as more downgrades are expected in Europe.

"A lot of traditional investment-grade buyers in both Europe and the US are dipping into the BB market in a meaningful way to pick up some incremental return," says Mathew Cestar, head of leveraged finance in EMEA at Credit Suisse in London.

Fallen angels

Mr Cestar notes that Credit Suisse anticipates more so-called fallen angel companies moving down from investment-grade BBB to high-yield BB next year, either because of sovereign downgrades or their own credit metrics in a weak European economy. There is an estimated €300bn in outstanding debt (both bank loans and bonds) for European companies rated BBB- with a negative outlook, BBB- with a stable outlook or BBB with a negative outlook, any of which could be vulnerable to downgrades below investment grade.

As some of these companies are downgraded it will increase the universe of European high-yield/investment-grade crossover names issuing in the US, as well as making euro-denominated offerings, and Mr Cestar expects crossover corporate deals to feature more strongly in the bond market in 2013. For example, Energias de Portugal did its first sub-investment-grade deal in September, with Credit Suisse as one of the joint bookrunners on a €750m offering.

Many BB rated credits will also be issuing in euros, where investor appetite is still running at high levels, but the US high-yield market tends to have a more continuous bid, whereas European investors suddenly pull back in times of bad news and high volatility, particularly for lower rated issuers.

"There is a more consistent buyer base in the US market for low B or CCC rated issuers, while in Europe most of the demand for high-yield bonds is focused on strong B or BB rated names," says Mr Cestar.

Crossover deals

There is a particularly high level of demand at the crossover space. This comprises either companies with split ratings, or those perceived to be on the way up to investment grade or coming down to just below. These can often be high-yield deals marketed partially to high-grade accounts.

"BB rated corporates are continuing to take advantage of the intersection of demand from long-only high-yield investors and traditional investment-grade investors seeking incremental yield available from high-quality non-investment grade corporates," says Mark Walsh, co-head of leveraged and acquisition finance at Morgan Stanley in London. "In addition, another key investor trend, particularly in the US, has been the surge in importance of exchange-traded funds as a driver of buyside demand."

Notably, many European corporates have opportunistically accessed the US dollar market in 2012, taking advantage of US-based investor appetite combined with attractive cross-currency swap markets to achieve all-in financings rates below where a comparable euro-denominated offering would price. This trend was very evident earlier in the year, as issuers tapped into strong investor demand and highly competitive swap markets.

"Big global funds in the US can quickly shift from the domestic market to international issues, and this year they have been buying more US dollar bonds issued by European corporates as a way to outperform the US corporate bond market, where yields on the BB index have been at generationally low levels of about 5%," adds Henrik Johnsson, head of European high-yield capital markets at Deutsche Bank in London.

While US investor appetite has focused on European corporates, there is still lot of wariness towards eurozone banks. This followed a big pull-back in mid-2011, when even short-term money market funds drastically began to scale back their holdings of European bank commercial paper.

The bond markets were all but closed for some eurozone banks. But this situation has changed in recent months. In September, BNP Paribas came to the Yankee market with a five-year $1.25bn offering, followed soon after by deals from Crédit Agricole, Société Générale, and most notably an offering from Spanish bank BBVA. If US investor appetite for eurozone financial institutions is sustained, this would be an important boost for the troubled European economy as a whole.