The annual hunt by banks to find debut issuers in the European high yield bond markets has just started. But although funding costs have plummeted to historical lows, fewer first time borrowers are choosing this form of financing.
The share of new issuers of high yield bonds from January to September last year was just 16%, Moody’s data shows. For the same period in 2016 it was even lower, at 10%.
Debut issuers previously played a much larger role in the high yield market: more than 25% of issuance in the first nine months of 2015.
“We have seen fewer debut issuers in the last couple of years,” says Stephen Llewellyn, managing director, debt advisory at Rothschild in London. Rothschild has advised 13% of all European high yield debut issuers since 2012. “There are a number of reasons but a key factor has been clients turning to the institutional loan and the private direct lending markets, both of which have become much more competitive on terms and pricing.”
Quantitative easing by the European Central Bank has been the main driver of loan pricing down to exceptionally tight levels. But specialists believe that the complexity of the documentation for a high yield issue has also put off many potential debutants from choosing the market. In the past, they had fewer alternatives, but now borrowers are spoilt for choice.
“High yield bond documentation can be perceived as more complex compared to the loan market to first time bond issuers,” says Richard Etheridge, associate managing director in leveraged finance at Moody’s in London. “Weakening documentation in the loan market, such as covenant-lite, made loan financing a more competitive option for many issuers last year,” says Etheridge, adding that loans also offered “high investor demand, call option flexibility and lower disclosure”.
Issuers that do not like the onerous documentation for high yield are going to other markets besides leveraged loans, like direct lending or even the Schuldschein market.
From high yield investors’ point of view, this is worrying. They complain about the lack of new high yield bond issuers to diversify their portfolios.
One of those investors is Gregor Taraszow, senior high yield fund manager at Bantleon Bank in Zurich. In his view this means the issuers that still come to the high yield market are not necessarily the best.
“With yields this low for so long across markets, every company that needed to raise capital for the first time has already got it,” he says. “What remains available for high yield are the hairy ones, which is also why they deploy their power in this issuer’s market to erode covenants and documentation.”
There may be fewer new borrowers, but they are coming out with the most aggressive capital structures since 2011, according to Moody’s.
High yield documentation may feel exhaustive for first time issuers, but it is unavoidable, say specialist lawyers.
“Documents can reach 500 pages today,” explains Luke McDougall, leveraged finance partner at law firm Paul Hastings in London. “It covers the manifold situations in which a covenant may be breached or a particular payment defaulted. There is no way we can turn a credit agreement or offering memorandum into a four page summary for first time issuers.”
Schuldschein documentation, by contrast, can be as little as 20 pages.
However, for issuers willing to make the effort, and perhaps having fewer funding options, the high yield market can still offer investors willing to do serious credit work and understand sometimes challenging stories.
“The high yield market is able to manage stories on which term loan lenders struggle to put their finger,” says Tanneguy de Carné, global head of high yield capital markets at Sociéte Générale in London. “For instance, credits from the retail industry. Spanish clothing retailer Cortefiel’s first-time bond issue in September was a case in point. High yield has reached a level of maturity that it can reward the efforts of borrowers in those sectors.”