Note: This is Part 2 of a longer form analysis on the European HY market YTD which was published to 9fin subscribers last week. You can find Part 1 here.
Too Long Didn’t Read
More fixed rate notes are being issued with security, irrespective of rating
Spreads between single B and double BB tightened to +120 bps in Q1 2020, peaked at +296 bps in Q2 2020, but remained wide at +270 bps in Q4 2020.
Some of this spread divergence can be explained by issuance from the higher end of the double BB class, and/or from the lower end of the single B class.
Trend away from floating toward fixed rate notes
Secured HY debt has expanded its market share versus leveraged loans (55% in Q4 2020)
If we take a closer look within the single B and double BB classes, for fixed rate notes there is a trend toward more secured debt, irrespective of rating.
In single B - where security is more common by nature - by count of deals, Senior Secured Notes (SSN) increased from around 70% of deals in 2017/18, to 82% in 2020. By volume, SSNs increased from 63% in 2017/18 to 83% in 2020 with the step change occurring during 2019.
For double BB, there was a marked decrease in the share of SSNs from 2017 to 2018. However, from 2018 to 2020 this has reversed to post a gradual increase - by both count (10%) and volume (12%).
Issuance Yields Diverge in 2020
For investors - or indeed anyone - who believes rating agencies provide an accurate proxy of risk, it now appears single B is where the value lies. Spreads diverged throughout 2020, with double BB tightening once again in the fourth quarter.
Despite average issuance yields increasing throughout 2018, the spread between double BB and single B held steady at around 210 bps. From Q1 2019 through Q1 2020 we saw the spread between the two groups tighten dramatically to a low of just 120 bps.
We then encountered the market's reaction to the pandemic. Even for those firms who could access funding, yields pushed up to around 6% across single Bs, and a high of 3.9% in Q3 for double BBs. Q4 2020 now shows an average spread of 270 bps.
Yield incorporates any OID or above par pricing on tap issuances
Issuance from the higher end of the double BB class, and/or the lower end of the single B class may explain some of the spread divergence.
For those looking to delve a little deeper, the over-trend spikes in spread (Q1 2019 and Q2 2020) can be partially explained by a more granular analysis within each rating class.
For Q1 2019 (spread: +252 bps), the average BB issuance was nudging toward the top end of the class (9fin Score 11.6; equates to somewhere between BB and BB+).
While in Q2 2020 (spread: +296 bps), we see the dual effects of lower rated single Bs (9fin score 8; equates to B), and higher rated double BBs (9fin Score 11.5; equates to somewhere between BB and BB+).
The presence of ‘stressed-refi’s’ are another important driver of this divergence. Lowell GFKL’s €740m and £400m 2025s, and €600m 2026 sit at the higher-end of the single B class, but printed with chunky yields in the high 6s. Similarly, Boparan’s new £475m 2025s (B3/B) were priced 19 November at a 7.625% yield.
Pure Gym on the other hand does conform, printing at similar yields to the Lowell EURs after being marketed with a 8-handle, but rated B3.
Fixed or Floating?
Meanwhile, (Figure 14 and 15) we can see a trend away from floating, toward fixed rate debt. Although some of this trend is likely due to the ever-lower interest environment, the sharper movement seen from 2019 to 2020 could indicate a lack of demand from new CLOs - hit hard earlier this year - but seeing a resurgence of late.
Note: ‘fixed’ category includes SUNs and SSNs, while ‘floating’ includes SUN FRNs and SS FRNs issued over the period.
High Yield Stolen Share?
Secured HY debt has expanded its share versus the leveraged loan market from 31% in 2019, to 35% in 2020, a trend driven by the increased issuance of Fixed, rather than Floating Rate SSNs (from 24% to 33% over the same period). Using quarterly data, the difference is more stark - during 2020 Secured HY shifts from 28% in Q1, to 55% by Q4.
An increase in secured bond offerings (€38.6bn YTD-20 vs. €34.3bn FY-19) coupled with a slump for term loan issuance (€64.4bn YTD-20 vs. €74.8bn FY-19) - has driven HY to comprise the majority of transactions for the first time in the fourth quarter.
Research published by S&P suggests that since April, pricing in the Loan market for single Bs has become cheaper for issuers than for Bonds, however, the latter has shown a higher tolerance - at a price - for the risk seen during the pandemic. In addition, for the best credits, bonds often still provide a cheaper financing route for companies.
From a supply point of view, issuers looking for long term financing happily forewent the structural advantages of soft-call loans or NC1 FRNs. From the demand side, investors securing higher yields didn’t want the debt rolled over or refinanced at a cheaper rate, after a short spell of call protection.
Market dynamics were unfavourable for CLOs for much of 2020. For existing vehicles sub par bids on existing holdings meant selling now to participate in a new primary deal would crystallize a loss and eat into returns - one of the drivers for an uptick in OIDs in covid-19 era loan primary. However, up from a yearly low of 78.92, the average bid on the Europe All Loans Index now sits at 96.31 (close 13-Nov) - suggesting a rosier outlook for one driving factor for loan issuance.
Despite the pandemic, we are tracking towards near record high issuance for 2020, with larger deals and proportionately more highly-rated, secured, or fixed-rate debt offerings.
While spreads had blown out, there are already signs of double BBs tightening once more back towards historical levels.
Steady central bank and government stimulus - boosted by vaccine news - has offered encouragement to HY, with even the more stressed issuers printing successfully. Moreover, some HY names are (for once) printing with attractive yields, and visibility is far greater than six months ago - helping temper investor fears. The outlook is on the up, and it remains to be seen how far 2020 issuance will close the gap to 2017’s plentiful supply.
Bankers already suggest the pipeline for the first quarter of 2021 looks healthy. Deals expected in the near term include Asda, Caesars-William Hill, Fugro, Golden Goose, Pasticceria Bindi, IMA, and Styrolution.