The FINANCIAL — Fitch Ratings-Frankfurt/London — Fitch Ratings says European High Yield (EHY) issuance has continued its record setting pace in 2011, with around EUR24bn issued thus far and the market on pace to surpass its record issuance of EUR34bn in 2010, potentially before the end of the summer.
"New issuance, principally from legacy leveraged buyouts requiring maturity extensions, continues to be supported by strong institutional and retail flows into the high yield asset class", says Matthias Volkmer, Director in Fitch's European Leveraged Finance Group, Frankfurt. "So long as the spectre of defaults remains low, institutional and retail investors have few alternatives in their search for yields," Volkmer added.
The trailing 12-month EHY default rate remained as low as 0.7% during the first quarter of 2011 (Q111). This was based on a total LTM default volume of EUR1.8bn, which included only one default, Czech lottery firm Sazka, which missed a principal payment in January. Notwithstanding current issuance and default trends, in Fitch's latest 'European High Yield Issuance and Default Review and Outlook' (published in March, 2011), the agency said it expects the outlook for default rates to increase towards the second half of 2011 and into 2012, as new issuance continues to reflect riskier credits with more aggressive structures.
Specifically, the share of 'CCC' and below rated instruments increased to approximately 12% during Q111, from low single digits in 2010, showing the market's willingness to extend credit to the more leveraged borrowers in more challenged sectors. The trend has continued in Q211 with low-rated first-time issues from UK-based travel agency Geo Travel, which issued an eight-year EUR175m senior unsecured note to support the acquisition of Opodo by sponsors Permira and Axa. In addition, Swedish provider of leisure products, Dometic Group, issued an eight-year EUR200m subordinated PIK bond to support the company's buy-out by EQT, and UK Gaming group Gala Coral will today attempt to price its upsized GPB350m in senior secured notes and downsized GPB275m subordinated notes as part of its ongoing financial restructuring.
"Borrowers in challenged sectors or with high leverage have few cost-effective funding alternatives given declining risk appetite for loans from Europe's deleveraging banking system," said Edward Eyerman, Managing Director in Fitch's European Leveraged Finance Group, London. Fitch notes that banks continue to suffer high funding costs as uncertainty prevails over implementation of tighter regulatory capital requirements and exposure to sovereign risk. "The pressures on the banking system in turn raise the costs for banks' lending to speculative-grade corporate borrowers in terms of pricing, leverage levels and covenants. This translates into increasing borrower preference for more favourable terms in the high yield market," Eyerman added.
In addition to record flows into high yield funds that provide demand for fixed-rate note issuance, Europe's Collateralised Loan Obligations (CLOs) continue to invest in floating-rate note instruments in the absence of new primary market loans. Specifically, a substantial rise in unscheduled prepayments on legacy loans held by CLOs, from high yield note re-financings or outright sales of leveraged borrowers need to be reinvested in eligible collateral, which includes floating rate notes for many CLO funds. Proceeds from these repayments represent a recycling of low cost funding arranged in 2006 and 2007, which can be effectively channelled into a debtor-friendly, covenant-lite floating-rate note instrument that competes favourably against the more expensive bank loan market and further lures borrowers towards high yield issuance.
Source: Fitch Ratings
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