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Fixed-Income: Reverse-Yankee High Yield Bond Issuance Soars

reverse yankee

Speculative-grade debt issuers from the U.S. tapped the European high yield bond market at a record pace in 2018’s first half, taking advantage of decidedly cheaper financing costs in that market.

During the first six months of the year there was €8.2 billion of this ‘reverse-Yankee’ activity, an increase from €5.6 billion in 2017’s second half, and well up from levels seen in 2010 through 2014, according to LCD.

Why the surge in reverse-Yankee activity?

single b yields

Simply put, the European high-yield market, via euro-denominated deals, is a less-expensive financing option for U.S. issuers. For lower-rated companies, for instance – issuers rated single B – Europe has during the first half of the year offered financing that averages 156 bps cheaper than in the U.S., according to LCD. That’s up from a 125 bps difference in 2017’s first half.

This analysis was excerpted from a story on LCD News by Luke Millar.

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Leverage Loan Returns Sink in Europe as Investors Shift Focus Within Segment

europe leveraged loans

In June, the European secondary loan market experienced its worst returns in two years. However, unlike in June 2016 — when the market was reacting to a geopolitical event, namely the U.K.’s Brexit vote — this year the trigger was market-driven, with secondary prices tumbling as loan investors rotated out of lower-priced names to take advantage of higher yields amid a rapidly repricing primary market.

As a result of steep secondary price declines, the S&P European Leveraged Loan Index (ELLI) lost 0.43% last month — the first time this measure has been in the red this year, and the worst performance since the 0.60% loss recorded in June 2016. The first five months of 2018 delivered positive (albeit unspectacular returns), averaging 0.27% per month (excluding currency fluctuations). For the year through June 30 the ELLI was up 0.90%, a far cry from the 2.65% gain racked up in the first half of 2017. – Marina Lukatsky

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Video: M&A Boom Drives European Leveraged Loan Issuance, Amid Widening Spreads

europe M&A

 

In the latest Capital Markets View video, LCD’s Taron Wade and S&P Global’s Chris Porter talk about the main trends in the European leveraged loan market. Discussed this month:

  • M&A-related financing made up more than 80% of total leveraged loan activity in the second quarter to mid-June.
  • This is being driven in part by the global M&A boom. All announced acquisitions in Europe and the U.S. combined increased by 81% year over year to June 15, to $1.2 trillion, according to data from S&P Global Market Intelligence (this includes investment-grade companies, and only covers transactions of more than $100 million in size).
  • There is a longer-term disintermediation trend in Europe, whereby companies are diversifying their capital markets exposure from primarily bank lending.
  • There has been an increase in loan spreads and CLO liability pricing, as well as a pushback on loan documentation.
  • Average starting margins for a decent single-B credit have moved 50 bps wider since the end of last year.
  • The percentage of flexes to have moved pricing wider has risen, from only 20% in January, to 50% in May.
  • Secondary loan prices have cooled as investors make room for higher priced, more desirable credits in primary, while there is more risk aversion in the leveraged finance markets generally.

The URL for the video: https://www.spratings.com/en_US/video/-/render/video-detail/capital-markets-view-june-2018

Taron Wade heads up LCD’s European Research efforts. Chris Porter is Head of Loan Recovery & CLO Business Development, S&P Global.As ever, please feel free to contact Taron or Chris if you’d like a particular topic discussed in next month’s video.

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AAA CLO Spreads Continue to Rise Amid Supply Surge

AAA spreads

After tightening below the psychological 100 bps mark earlier this year, AAA spreads of five-year reinvestment period CLOs have been widening since March due to a heavy supply of both new issue CLOs and reset of existing deals, according LCD.

AAA spreads, which make up about 60% of a CLO’s total financing costs, touched a post-crisis low of 93 bps in March. They averaged 98.47 bps over the month, before a pickup in resets and an active new-issue pipeline increased average spreads to 102.53 bps in April and to 108.06 bps in May.

CLOs – collateralized obligation vehicles – are special-purpose finance vehicles set up to hold and manage pools of leveraged loans. The vehicles are financed with several tranches of debt (typically starting with a triple-A rated tranche, then proceeding down the ratings ladder, to subordinated debt) that have rights to the collateral and payment stream, in descending order.

They are a critical part of the leveraged loan investor universe, and their issuance has boomed over the past few years as cash-rich institutional investors struggle to find higher-yielding investments.

From an LCD News story by Andrew Park. Follow Andrew on Twitter.

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Leveraged Loan Issuance Gains Steam in Europe, thanks to LBOs

europe leveraged loan issuance

Strong demand from collateral loan obligations helped European loans work through a generally volatile May to post strong new-issue volumes.

M&A was the clear driver for European loans in May, providing €8.5 billion (when including LBO and other related deals) out of a total new-issue volume of €10.5 billion, according to LCD. This meant M&A was responsible for roughly 81% of deals last month, following a not-too-dissimilar share in April (when acquisition-linked loans brought a nearly 90% of supply).

This M&A-led market is certainly what investors had been asking for at the start of the year, having been through several refinancing spikes over the previous 18 months or so. These deals had helped keep reported volumes high, but did not always help those players looking to add assets or maintain returns.

Year to date, leveraged loan issuance  in Europe targeted for institutional investors totals €41 billion, on par with activity at this point last year. – David Cox

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Europe’s CLO Market, Already Red-Hot, Looks to Go Green

The world’s first green CLO is on its way amid a growing sustainable finance market and a push from regulators to scale up green investments to tackle climate change.

While the private sector has already been developing markets for green assets, such as green bonds and loans, increased global regulatory coordination is in the offing to support further growth of green financing, in particular the creation of a sustainable securitisation market.

One European manager, which focuses exclusively on investment in clean energy infrastructure, is working on the first green CLO, according to sources. It will also be the manager’s first CLO issue.

global CLO 1Permira Debt Managers took an initial step in March towards creating a sustainable CLO market by making its €362.5 million Providus I vehicle compliant with environmental, social, and governance (ESG) criteria. The manager’s future CLOs are also going to be ESG compliant, sources say.

ESG criteria calls for socially responsible investments and prevents a fund from investing in certain industries (such as speculative extraction of oil and gas, weapons and firearms, tobacco, gambling, and payday lending, among others).

A green CLO focuses on the “E” in ESG. Sources say the upcoming vehicle will invest solely in green sectors and projects that have a positive and so-called “global cooling” environmental impact, such as renewable energy and energy efficient transportation.

A revolution
Sustainable (or green) CLOs, along with other sustainable structured products “are set to turbocharge sustainable finance,” wrote White & Case partners Chris McGarry and Debashis Dey and counsel Mindy Hauman in a client alert in May. “CLOs will be a pillar of the sustainable securitisation revolution,” they added.

The green finance market is still at a nascent stage, but it’s growing rapidly and will benefit from certain accords. Indeed, to reduce climate risk in line with the Paris Agreement, the United Nations estimates that $90 trillion of investments are needed in the next 15 years to build out sustainable infrastructures that include everything from energy to public transport, buildings, water supply, sanitation, and so on. The Organisation for Economic Co-operation and Development (OECD) estimates annual issuance of sustainable asset-backed securities (ABS) could reach $350 billion by 2035 and notes that it is the fastest growing product under the sustainable finance umbrella.

Other forms of sustainable securitisations include ABS made up of sustainable auto loans, solar loans, and Property Assessed Clean Energy (PACE) loans, as well as mortgage-backed securities for green residential and commercial properties.

“We are pushing hard for green securitizations because the scale of investments around the world to achieve low carbon is so vast that the balance sheets of banks are not going to be able to cope, especially as the banks need to recapitalize,” says Sean Kidney, CEO of the Climate Bonds Initiative (CBI), an organization which aims to develop a liquid green and climate bond market and which partners with banks, bond issuers, institutional investors, law firms as well as ratings agencies and other institutions.

Global issuance of green bonds totaled $160.2 billion in 2017, up 85% versus 2016. The CBI forecast for 2018 calls for the global green bond market to grow to $250–300 billion. The U.S., China, and France accounted for 56% of 2017 issuance. U.S. government agency Fannie Mae was the largest issuer of Green MBS in 2017 at $24.9 billion.

Some existing CLO managers are somewhat skeptical about the green securitisation market though, given that it remains relatively niche, but they say the theme is becoming more and more topical.

“We haven’t written ESG criteria into our CLO documentation, but we have ESG watch flags in our investment processes. Lots of institutional investors are stressing the importance of it, but it needs to be clear that this should not only be a marketing strategy to boost reputation,” says one CLO fund manager.

It is not just specialist investors, but also global managers that follow sustainable investment strategies. “Asset managers like Amundi and BlackRock, but also several commercial banks’ treasuries invest in green bonds,” says Tanguy Claquin, head of sustainable banking at Credit Agricole CIB, which ranked as the top arranger of green financing in 2017, according to various league tables. Claquin also sees large potential for growth in the green securitisation market.

Definition
A lack of clarity remains around the definition of green/sustainability. The two phrases are often used interchangeably for investments that have a positive environmental impact.

So far there is no universal agreement on a definition. “Should nuclear energy be considered green? Given the diversity of opinions, it can be challenging to establish ‘standard’ definitions of green,” according to a report on green bonds published last December by The World Bank, Zurich Pension Fund, Amundi Asset Management, and Actiam.

A number of initiatives have been put forth though to set standards. In March, the Loan Market Association launched the Green Loan Principles (GLP) to help growth of the global green loan market. The GLP builds upon the Green Bond Principles (GBP) of the International Capital Market Association (ICMA) and sets voluntary guidelines to promote transparency and disclosure, along with second-party opinions. S&P Global Ratings has the Green Bond Evaluation service, while Moody’s provides the Green Bond Assessment. CBI also provides an extensive taxonomy and certification for green bonds.

global CLO 2While certifications can create extra costs and operational efforts, fund managers like them as they help with due diligence processes to assess a bond’s use of proceeds. “We and our clients want a lot of transparency so that we know how the proceeds are spent, even for future projects that an issuer—at the time of raising a green bond—has not yet selected. We want to make sure we know how the money really is spent,” says Foppe-Jan van der Meij, portfolio manager at Actiam, a €54 billion-plus Netherlands-based fund manager that complies with the Green Bond Principles for investing in green bonds as well as ABS.

The firm‘s investors are insurance companies, pension funds, and wholesale distribution partners like banks. “We are seeing a lot of demand. More and more investors are incorporating green goals and ESG criteria into their strategies. Retail investors are very keen to put money to work towards green bond funds. Returns are in line with non-green bonds, but their [secondary market] performance in a volatile market is more stable,” van der Meij adds.

CBI’s Sean Kidney also notes that while there is growing demand for green bonds, they pay similar spreads to comparable non-green bonds with the same tenor and currency and rating. “Investors don’t do it for the price benefit, they do it for the diversification benefit,” he says.

Asset sourcing
Sourcing enough assets to fill a green fund though is one major challenge for investors, they say, because the number of issuers active in the green bond market is still limited. Actiam said that for its mainstream €3 billion fund, 10% is invested in green bonds, including sovereign and corporates, while the remainder is invested in conventional bonds, although those still need to meet a minimum proprietary ESG score that is better than the benchmark.

White & Case argues this issue can be overcome, saying that there is a critical mass of assets available. “It is just a question of market education and re-examining potentially eligible assets for sustainability,” the law firm wrote in its May client briefing. Moreover, it adds that sustainable securitisations will help free up bank’s balance sheets, enabling them to arrange more deals.

For example, Credit Agricole last year transferred the risk of $3 billion-worth of project finance loans to Mariner Investment via a so-called green capital note (Premium Green 2017-2). As part of the transaction, it committed to use $2 billion of the $3 billion of freed-up capital for new lending in green sectors, such as renewable energy and energy-efficiency loans for commercial real estate and public transportation, among others.

This creates a “sustainable finance loop” that generates more assets on a rolling basis, White & Case says.

Regulatory landscape
The regulatory landscape is also starting to become more supportive of green investment, with a long list of legislative initiatives on the way to help drive investments. For example, under the simple, transparent, and standardised (STS) framework of European securitisation regulation, sponsors and originators will be required from January 2019 forward to disclose information on the energy efficiency of underlying assets in RMBS and auto loan securitisations in order to receive beneficial regulatory capital treatment.

The European Commission has also set up a “High Level Expert Group on Sustainable Finance” to address funding shortfalls and create plans for sustainable finance as part of the European Capital Markets Union. In its action plan published in March, the EC said it would establish a unified EU classification system or taxonomy to define sustainable investments, identify areas where sustainable investments can make the biggest impact, and clarify the duty of asset managers and institutional investors to take sustainability into account in the investment process and enhance disclosure requirements.

On a global level, the Bank of England and the People’s Bank of China as co-chairs of the G20 Sustainable Finance Study Group (SFSG) are currently developing plans to mobilize private capital for green investment, according to SFSG reports. This includes further research into the securitisation of sustainable assets, as approved in a meeting in February. The SFSG will hold its second meeting in early June and then submit a new report to the G20 Finance Ministers and Central Bank Governors Meeting in July and the G20 Leaders’ Summit in December. — Isabell Witt

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European High Yield Market Struggles through Grim Month of May

europe high yield issuance

May was arguably the most difficult month for the high-yield market in over a year and half, with choppy secondary conditions and rising new-issue pricing resulting in three deal postponements and a drop in volume.

There haven’t been three pulled deals in a month in recent memory, and while a slew of opportunistic borrowers also decided not to launch, such issuance was still the backbone of supply. Nevertheless, while the Italy-induced volatility curtailed supply in May, and might continue to do so until it subsides, a sizable event-driven pipeline continues to build.

This backdrop has been set during a month that started with a flurry of opportunistic activity, but ultimately saw total volume drop to €4.4 billion, down from the bumper months of March and April, when 21 and 29 bonds priced, respectively, for a total of €9.7 billion and €10.5 billion. Encouragingly though, year-to-date volume and deal count are running roughly even with the same period last year. – Taron Wade/Luke Millar

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Leveraged Loans – Amid Continued Investor Demand, Second-Lien Issuance Surges

US second lien

The leveraged loan markets in both the U.S. and Europe have seen a boost in the issuance of second-lien activity as institutional investors and retail loan funds (in the U.S.) continue their hunt for higher-yielding paper.

As the name implies, second-lien loans reside lower in a deal’s capital structure, meaning they are repaid after the more-senior tranches (the first-lien debt). Consequently, they are inherently more risky, and therefore are more richly priced.

In May, Second-lien issuance in the U.S. leveraged loan market surged to its highest level in eight months, to more than $3 billion.

Europe second lien

In Europe, second-lien loans are rapidly becoming European private equity shops’ favored choice when adding a subordinated layer of debt to buyout financings, and to boost leverage. This activity has hit post-crisis highs, as the deep demand for paper threatens to push out high-yield bonds from all but the largest capital structures.

Indeed, the resurgence in second-lien is changing the very make-up of Europe’s buyout market. For the first time in the post-crisis era, the portion of buyouts taken by first lien-only structures has fallen below 50% this year, to 45% of deals, according to LCD. First lien-only structures were last year responsible for 61% of buyout transactions, and 75% in 2016. – Staff reports

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S&P Global: Europe’s Leveraged Finance Market Could Ride High Into 2019

Europe’s leveraged finance market is likely to stay buoyant for at least the rest of 2018, and probably the best part of 2019, says S&P Global Ratings in a report titled “How Long Can Europe’s Leveraged Finance Market Bonanza Last?

“As long as Europe’s growth cycle remains on track and is supported by quantitative easing and exceptionally low rates, we believe the operating environment is likely to be supportive,” said S&P Global Ratings in the report. “This is despite a number of potential problems that could trigger a turn in the market, most of which are external.”

The agency goes on to say that after €94 billion in high-yield bond issuance and €120 billion of leveraged loan issuance in 2017, market volumes are holding up in 2018, with €30.1 billion in bonds and €41.2 billion in loans issued in the first four months of the year.

The report states that causes for optimism include the improved credit performance of European corporates in recent months — with rating downgrades versus upgrades for high-yield issuers moving close to being balanced — and that this is backed by a macro environment that is supportive of operating performance, cheap funding conditions that are boosting the interest-coverage ratio, and a relatively prudent financial policy. Leverage has increased, but Europe sees less shareholder-friendly activity than in the U.S., where dividend payments and share buybacks tend to be a more prominent feature, S&P Global Ratings adds.

Another positive is the debt maturity profile, which gives companies some breathing space. Many issuers opportunistically refinanced their debt leveraging in the past year’s very favourable conditions, and debt maturities don’t pick up until 2021, thereby mitigating short-term risks, the agency adds.

“All this indicates to us that the tide is not yet ready to turn in Europe in 2018, and perhaps not even in 2019,” says the report. “As a result, we expect the corporate default rate in EMEA to remain very low at 2.5% by the end of 2018.” — Luke Millar

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Free Research – 17th Annual European Leveraged Finance & High Yield Conference

S&P Global was pleased to present recently its 2018 European Leveraged Finance & High Yield Conference: How Close Are We To the Top Of The Cycle?

europe PE

The conference featured a presentation by LCD’s Taron Wade regarding the intense institutional investor demand that is shaping the speculative-grade debt markets. The charts backing that presentation detailed trends and developments driving today’s market, including

  • European M&A activity, by specific use of proceeds
  • Trends in buyouts
  • Direct lending’s effect on the leveraged finance market
  • Yields on leveraged loans, Europe vs U.S.
  • The accelerating European CLO market
  • New issuance vs investor demand, European leveraged loan market
  • The increasing reliance on cross-border loan financing
  • The equity component of LBO financings (above)
  • … and, of course, the surge of covenant-lite loan issuance

The presentation also includes a panel discussion on risk of disruption in the credit cycle, a conversation regarding green investing, and a separate panel discussion on structural features and/or risks in today’s finance market.

You can download the slides backing Taron’s presentation here.

You can view the conference here. 

Both are complimentary, courtesy S&P Global Market Intelligence and LCD.

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