European LevFin Wrap — Markets in ‘wait-and-see’ mode as rising yields spook borrowers

Alessandro Albano
+Owen Sanderson

26 October 2023•7 min read

European HY bonds paused this week, following a fresh bout of rates-induced volatility across assets, though primary loan markets powered on, buoyed by still-strong technical support.

“Two months ago markets expected rates not to go higher with few cuts priced for 2024, now this option is no longer the baseline. Everybody is in a wait-and-see mode,” an investor told 9fin.

Meeting in Athens to celebrate Greece's resurgence, the ECB offered some relief by holding its key interest rates for the first time after 10 consecutive hikes, the longest streak in the bank's 25 year history.

However, the move was widely expected and ECB president Christine Lagarde rapidly cut investors' enthusiasm for cheap money, saying in the press conference, “We're holding, it doesn't mean we won't hike again in the future.”

The central bank carefully stated in the decision announcement that current rates level will make a “substantial contribution” to the 2% inflation target if maintained for “a sufficiently long duration”, with Lagarde later noting that “inflation dropped markedly in September” while yields “had risen markedly since our last meeting”.

But how long is sufficiently long? It's the €100bn+ question that markets have started to answer as they optimistically move to price in a 25bps cut for as early as next June (June 2024 OIS futures).

European bonds also underwent a steepening rally on the back of softening inflation and weak PMI data, with the 10-year Bund ending ECB day at 2.86%.

The latest data from the bloc has shown the historic rate-hiking campaign has been having a big impact on lending and growth conditions.

The ECB’s Q3 Bank Lending Survey demonstrated only a marginal improvement in the last quarter’s credit conditions and again fell below the optimistic expectations of European banks from the last quarter.

October flash PMIs delivered a concerning alarm over the euro area’s growth outlook with the Eurozone Composite PMI Output Index reaching a 35-month low at 46.5 in October (September: 47.2).

High yield

“ITraxx Crossover spreads jumped to 473bps from about 370bps in two weeks, in this environment it is very difficult to get bonds out,” said a second buysider, discussing why we haven't seen a single EHY deal for three consecutive weeks (we will disregard the €140m Nordic issue from PHM for these purposes).

According to Natixis research, although September proved to be rather dynamic (€4.8bn issued versus €1.4bn in September 2022), October was very weak again supply-wise with €0.85bn priced MtD in euros.

Looking ahead through to the end of the year, there aren’t many reasons for EHY to pick up again.

“A lot of companies refinanced earlier this year, so we're not facing a huge maturity wall and companies can wait for better market conditions. I would be surprised to see the market picking up by the end of the year, but we will presumably see a strong beginning of 2024,” said the investor.

Contacted by 9fin a senior banker offered three major factors to unravel the HY dilemma.

“First is the higher-for-longer thesis creates a huge refinancing risk in 2024-2025. Second, with rates at this level the leverage becomes secondary, and interest coverage ratio plays a more important role. There are plenty of companies in the B- rating spectrum that won't be able to service their debt. Third, the increasing budget deficit in the US might become a problem. If they continue to issue Treasuries at the current pace, that will push rates even higher, and then inflation might start increasing again due to concerns over the deficit, an awful mix for fixed income investment instruments.”

Touching the second point, the Natixis team noted that in the current bear steepening environment “low-rated companies will suffer from bigger impacts on coverage ratios when refinancing, and are more at risk of a potential hard-landing (which is a more likely outcome if rates stay high for an extended period of time).”

Total return were negative in October for both euro and dollar HY markets, with the latter underperforming due to the increase in rates.

Natixis reported €1.1bn of net outflows in EHY funds since the beginning of the month, and -$7.4bn in US HY funds with global default rates increasing to 4.5% in September versus 4.3% in August.

Switching to valuations, “despite the recent spread-widening movement, we are still far from fair-value levels expected for year-end around OAS+440bp for euro-denominated HY,” Natixis added.

If primary has been quiet, secondary markets have been stimulating, with earnings season prompting a few surprises.

Among them, Irish packaging solutions company Ardagh Group's €1000m SS PIK Toggle notes saw yields rise to about 22% on a YTM basis after the company's Q3 earnings showed 6.9x net leverage and higher than expected capex. See the full Q3 call transcript here.

If primary has been quiet, secondary markets have been stimulating, with earnings season prompting a few surprises.

Spanish fashion retailer Tendam posted strong H1 2024 (financial year ends February 24) results, while simultaneously confirming that a much anticipated IPO could be in their plans. Consequently, Tendam's 2028 €300m FRN rose to 101.33.

Read the Earning Digest here.

Leveraged loans

Loans are still undersupplied relative to at least six new issue CLOs in marketing this week (Barings, Partners Group, Five Arrows, MV Credit, AB CarVal, Sona) but a week with two dual-currency deals in can’t be all bad.

Enterprise software firm SUSE raised a well-flagged dual tranche €500m and $675m TLB at 450bps over Euribor / SOFR and 98.5, the tight end of the 98-98.5 talk. The deal funds EQT’s take-private of the German company, announced in August but formally agreed last week before the loan launched to general syndication.

It’s a little like the story of Cinven and Synlab. EQT floated SUSE in the halcyon days of 2021 at €30 per share, stayed heavily invested, and is buying it all back again at €16. Cinven did much the same with Synlab, selling at €18 in 2021 and now bringing forward a take-private at €10.

SUSE priced at the tight end via physical bookrunners Goldman Sachs (left), Bank of America, Deutsche Bank and JP Morgan. But it didn’t clear the market unscathed, with a big pack of docs changed announced just before pricing; blockers for J-Crew and Chewy-type transactions, resetting baskets and cashflow sweeps to opening leverage, committing to a quarterly management call.

It’s an open question whether these are real concessions from the sponsor or just the removal of the most egregious asks; 9fin’s legal team have a Legal QuickTake, while you can go deeper on the company here.

Animal pharma firm Ceva Santé Animal also priced a dual-currency deal this week, marking its debut in the dollar market. It’s levered and it’s tightly priced at 99 and 425bps in both currencies, but the credit is a defensive crowd-pleaser.

Use of proceeds includes a distinctly undefensive €250m dividend, but lenders felt this was justified given that Ceva has repeatedly demonstrated its delevering capabilities. Purely on technicals, this was also a solid proposition; the group had an existing €2bn euro facility which was being trimmed down to €1.8bn, so there was actually negative Ceva supply in euros. The balance of the borrowing came from a $540m dollar TLB, the company’s first in the currency.

JP Morgan and Barclays shared physical bookrunner duties on the euros, with JPM sole on the dollars.

Unlike Action the week before, which has no natural dollar need but wanted to broaden its funding base, Ceva had a substantial North American operation which it makes sense to fund via dollar loans, especially if these can hit the $500m+ size needed to attract attention from US PMs.

Also funding a dividend this week was a substantial private placement from Europa University Education Group, announced by sole bookrunner BNP Paribas as a €480m deal already priced and allocated on Monday at 98 and 450bps. The company, a private education group, is unrated and with no financials available, so perhaps privacy is particularly important here. The far better known education credits Nord Anglia Education and Gallileo Global Education have recently been in the market with repricings, reflecting strong performance in the sector.

Just before this wrap went out, INEOS Quattro announced a €2bn-equivalent dual-currency loan deal (expected to be €850m in euros), which, together with €800m-equivalent of bonds, will address 2026 maturities and pay for the $490m acquisition of a chemicals facility in Texas City. The deal will be marketed next week with commitments on November 8.