Our thinking

European leveraged finance: A bifurcated balancing act

What's inside

Growth in the European leveraged finance market remained steady in 2019, with 2020 set to continue at pace, with enhanced focus on the trade-off of protection from risk versus a higher yield
 

Foreword

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.

Data dive: European leveraged finance 2020

  • The covenant-lite share of European institutional loan issuance in 2019 reached 92 per cent
  • European leveraged loan issuance in 2019 was down slightly on the previous year to €209.1 billion
  • High yield bond issuance jumped more than 20 per cent to €95.5 billion
skyline frankfurt

Leveraged loan issuance: Lenders look beyond buyouts

  • Buyouts and M&A secured a combined €75.4 billion of loan issuance in 2019 
  • Proceeds used for buyout issuance alone were down by more than 30 per cent to €38.7 billion when compared to the €56.6 billion total in 2018
coins

CLOs: New pockets of sustainable growth

  • European collateralised loan obligation (CLO) new-issue volume reached €30.1 billion in 2019
  • This was 11 per cent above the €27.2 billion netted over the previous year
  • The fourth quarter of 2019 saw €8 billion in CLO issuance
eco-friendly urban architecture

Restructuring: When is the right time?

  • Default levels remain historically low at 1 per cent to 2 per cent
  • Prevalence of cov-lite loans in Europe may be concealing some underperformance, but there are no conventional triggers for lenders to act
city lights fence

Public-to-private: Private equity on the hunt for new value

  • In 2019, European take-private deals backed by private equity reached €34.5 billion over 31 deals
  • This is 14 per cent higher than 2018 and more than five times the total deal value seen just five years earlier
  • Equivalent UK total deal value in 2019 was more than double the year before

European leveraged debt in focus

Selected European leveraged loan and high yield bond markets by volume and value

Regional focus: Spain finishes strong by Fernando Navarro, Partner, White & Case

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."

Sector watch: Hot or not?

  • Industrials and chemicals in aggregate accounted for the largest share of loan activity (20 per cent) and high yield bonds (22 per cent) in Europe
  • Pharma, medical and biotech issuers were the second most active in European leveraged loans, (14 per cent of deals in aggregate)
  • Services topped the list for loans in Europe with 11.2 per cent of issuances for the region

Conclusion

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

eco-friendly urban architecture

CLOs: New pockets of sustainable growth

Insight
|
4 min read

HEADLINES

  • European collateralised loan obligation (CLO) new-issue volume reached €30.1 billion in 2019
  • This was 11 per cent above the €27.2 billion netted over the previous year
  • The fourth quarter of 2019 saw €8 billion in CLO issuance

Demand for CLO exposure among investors grew in 2019, driven by a decade of low interest rates and cash, treasuries and corporate bonds offering minimal yield.

Data from Creditflux confirms the CLO's ongoing popularity: New issue volume achieved a post-crisis record, reaching €30.1 billion in 2019. This was 11 per cent up on the €27.2 billion in 2018 and more than double the €14.3 billion in new CLO issuance seen in 2014.

However, the benefits of the CLO model have the potential to extend well beyond delivering yields for pension funds and institutions.

The bond market—and CLOs in particular—have the reach and access to liquidity to raise the US$100 trillion the UN believes will be required to deliver its Sustainable Development Goals (SDGs) by 2030.

11%

The percentage rise in new issue CLO volume in 2019, up from the year before

 

CLOs and SDGs

The formation of sustainable CLO markets may be one of the best ways to fund environmental and other SDG projects at the pace required to confront climate change and to deliver the SDGs by 2030.

Banks alone will not be able to provide the necessary volume of sustainable lending. But fund managers can turn sustainable loans into tradeable, liquid CLO securities. While some broadly syndicated loan (BSL) CLOs have criteria that exclude investments based on sustainable environmental, social and governance (ESG) standards, these could be turned into 'SDG-positive' structures.

Such SDG-positive BSL structures will soon begin to appear in the market, while other types of SDG CLOs with different types of loan collateral are also in the works and expected in 2020—for example, SDG-aligned infrastructure loans, including clean-energy CLOs.

Ratings firms are already prepared to rate SDG infrastructure CLOs, and banks are planning both true sale and synthetic structures. This asset class is expected to develop in 2020 alongside SDG-positive BSL CLOs and SDG sovereign bonds.

 

Forward momentum

The market's coalescence around SDGs as the standard on which the sustainability of a CLO is judged is a game-changer for these new structures. The SDGs enable borrowers to enter into sustainability-linked loans and bonds.

Under sustainability-linked loans, borrowers could be penalised if they fail to deliver on the SDGs to which they had committed and incentivised with lower front-end coupons.

At the moment, there are not enough leveraged loans linked to SDGs, which means CLOs cannot realistically include minimum SDG benchmarks. Instead, SDGpositive CLOs will include economic incentives that will be triggered once the level has been ramped up with sufficient sustainable assets.

There could also be modification provisions, such as covenants designed to maintain minimum levels, and that would help SDG CLOs qualify as European Central Bank repo collateral in due course.

Investors in CLOs are already working with CLO managers to find ways to incorporate ESG elements into their decision-making when constructing leveraged loan portfolios. For example, ESG-focused Hermes Investment Management is reportedly having discussions with CLO managers to find out how they are engaging with ESG issues and to find ways for loans to improve those efforts.

Managers point to the lack of ESG-linked information provided by borrowers as an obstacle to deciding who has genuine SDG credentials. But with the introduction of SDG benchmarks and standards, nothing stands in the way of SDG CLOs' expansion.

We cannot wait for the regulators and central bankers to catch up; we need to get to work now.

 

 

This publication is provided for your convenience and does not constitute legal advice. This publication is protected by copyright.
© 2020 White & Case LLP

 

Service areas

Top