Debt & Capital Advisory In the debt markets An insight into current market conditions CEO & CFO summary June 213 In this issue: Outlook: CEO & CFO summary Leveraged loans High yield Corporate loans & bonds Schuldschein Corporates continue to diversify their sources of funding, buoyed by significant liquidity both in Europe and the US. Nick Atkinson Partner, Debt & Capital Advisory Conditions in the corporate debt markets have improved in 213 continuing last year s strong performance. An important new trend is that banks are once again liquid and open for business. This has resulted in loan volume growth outpacing the bond market, in spite of continued strong appetite from bond investors. Despite the availability of funding, acquisition activity has remained low. Corporate borrowers are mainly taking advantage of current conditions by improving terms of existing facilities through refinancings. Similarly, acquisition activity in the leveraged market has also proven disappointing. Sponsors and their portfolio companies are, however, proactively taking advantage of market conditions through refinancings, repricings and amendments of existing debt. In direct contrast to the key trend in the corporate market, non-bank sources of funding continued to be the key driver of activity in leveraged deals. Investor demand for high yield (HY) remains extremely high with record issuance in the first quarter of 213. This liquidity is further supplemented by significant appetite from collateralised loan obligations (CLOs) and an ever increasing list of specialist debt funds. Another noticeable development in the corporate debt market is the significant increase in hybrid and convertible bond issuance. The issuance of hybrid bonds in the first quarter of 213 exceeded previous full year highs. Investor appetite for both instruments is strong, as institutional investors continue to chase yield. Due to strong performance in the equity markets and as a result of how rating agencies may view these instruments, corporates consider hybrids and convertibles as an attractive alternative to raising equity directly. With continued investor appetite across the risk and product spectrum (bonds, private placements and loans), borrowers should take advantage of current attractive terms before liquidity in the markets reduces over the summer.
Leveraged loans Chart 1: European leveraged loan volume and debt multiples Chart 2: Analysis of primary and secondary loan pricing 18 6.x Value ( bn) 16 14 12 1 8 6 4 2-2Q1 3Q1 4Q1 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 Volume (Senior) Volume (Mezzanine) Total Leverage 5.x 4.x 3.x 2.x 1.x.x Total Leverage Average primary TLB YTM (bps) 6 5 4 3 2 1 - Apr-12 May-12 Jun-12 Jul-12 Average Primary YTM TLB Aug-12 Sep-12 Oct-12 Nov-12 itraxx Senior 5Y Financials Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 Average Secondary TLB/TLC Bid Price 88 87 86 85 84 83 82 81 Average secondary TLB/TLC bid price Source: S&P Capital IQ LCD Source: S&P Capital IQ LCD, Thomson Reuters In the 5 months to May 213 31.6bn of leveraged loans were issued in the European market, which is more than double the level of issuance in the prior year corresponding period. It is also higher than the 28.5bn of issuance in the whole of 212. The largest contributors, representing over 1.3bn of issuance, were Schaffler AG, Ista, UPC Holding, D.E. Master Blenders and Merlin Entertainment. The market is showing significant liquidity for the first time since the credit crunch. Technical conditions in the European market remain strong. New CLO issuance from investment managers including Cairn, Pramerica, Apollo, Alcentra and others in the pipeline, have further contributed to liquidity. However, regulatory uncertainty is casting a cloud over new issuance. The US market remains very attractive to European issuers driven by deep investor liquidity and looser covenant requirements. Doncasters, Allflex and CSM Bakery are three examples of companies that have recently chosen to raise funds in the US rather than in Europe. The European market is competing with the US market by reducing requirements around covenants. Transactions from Ista, Merlin and D.E. Master Blenders all feature fewer financial covenants than one might expect in Europe. As many CLOs in Europe exit their re-investment period, sponsors and arrangers have structured new refinancing transactions such as Merlin Entertainment, as an Amend to Extend, to allow existing CLOs to roll over their investment. We expect to see this structure being used in the coming months to refinance and extend transactions. Driven by growing liquidity, the prices of all classes of debt products are being pushed down. The average institutional spread dropped to E+427 for the three months to 3 April 213, down 12 bps from the first quarter and a four-year low. 1
High yield Chart 3: European BB and B rated bonds vs itraxx Crossover Chart 4: European high yield volume (primary issue) Spread (bps) 12 1 8 6 4 Value ( bn) 25 2 15 1 2 5 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13-2Q1 3Q1 4Q1 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 itraxx Crossover B Rated BB Rated Volume (HY) Source: Thomson Reuters Source: LCD Q1 213 overview Investor sentiment has turned cautious in June following a record breaking first five months of the year. High Yield (HY) investors are nervous of the US Federal Reserve ending its quantitative easing actions, and yields have risen, in line with other fixed income markets. The European primary HY market had a record first quarter in 213 resulting in issuance of 21.4bn, equivalent to 58% of total 212 volume. May was also a record month with issuance of 9.5bn. Until the widening of spreads in June, investors had demonstrated a strong level of risk appetite. The market has supported aggressive structures such as payment-in-kind (PIK) toggles. Europe has seen four such transactions this year including the most recent deals from R&R Ice Cream and Kloeckner Pentaplast. By comparison, only three PIK toggle deals were issued between the whole of 26-212, according to S&P Capital IQ LCD. Technical conditions in the European market remain strong with inflows into the market at around 3.7bn through May according to J.P Morgan. In the US market, Lipper data shows a net inflow of $2.5bn in 213 up to May. However technical conditions have since deteriorated with record outflows of $4.6 bn in the first week of June, pointing to a more turbulent summer period. 2
Corporate loans & bonds Chart 5: European corporate investment grade bond spreads Chart 6: Corporate loans and bonds volume (primary issue) Spreads (bps) 1 9 8 7 6 5 4 3 2 1 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Merrill Lynch European BB - B non-financial index Merrill Lynch Corporate BBB Rated Euro non-financial index Merrill Lynch Corporate Single-A Rated Euro non-financial index Merrill Lynch Corporate AA Rated Euro non-financial index Merrill Lynch Corporate AAA Rated Euro non-financial index Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Chart 6 - Corporate loans and bonds volume (primary issue) 1% 9% 8% 7% 6% 5% 4% 3% 2% 1% % 2Q1 3Q1 4Q1 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 Corporate Bonds Corporate Loans Total Volume (loans and bonds) 3 25 2 15 1 5 Volume ( bn) Source: Thomson Reuters Source: Dealogic Total debt capital market (DCM) volume in the first quarter of 213 increased to 257bn (up 15% from Q1 212). However, in contrast with the overall trend of 212, the increase was the result of a significant increase in loans (up 51% from Q1 212). This was only partly offset by a decrease in bond issuance (down 7% from Q1 212). In spite of significant bank appetite in this part of the market, investment grade M&A loan volume only amounted to $26bn. Increased bank lending appetite and resulting competition helped borrowers obtain financing on improved terms. Average pricing for BBB-rated European non-financial companies in Q1 213 reduced to 16 bps (down 2 bps from Q4 212). As a result lenders sought yield elsewhere, expanding their scope both in terms of instruments and geographies. There was increased activity in Spain and Italy as well as in hybrid and convertible bonds. Both hybrids and convertibles provide borrowers with an effective way to raise capital and strengthen their capital structure. Hybrids accounted for 15% of total euro bond issuance and 5% of sterling issuance. With continued appetite and liquidity across products (bonds, private placements, loans) and risk spectrum, borrowers should take advantage of continuously improving terms before markets shut down over the summer. 3
Schuldschein Chart 7: Schuldschein issuance Chart 8: Corporate Schuldschein volume by country Value ( bn) 2. 18. 16. 14. 12. 1. 8. 6. 4. 2. 28 29 21 211 212 German schuldschein issuance Non German schuldschein issuance Number of deals 14 12 1 8 6 4 2 Number of deals Germany 64% Austria 14% France 9% Benelux 4% Southern Europe 3% United Kingdom 2% Other 4% Source: Thomson Reuters LPC Source: Thomson Reuters LPC A Schuldschein loan is the German equivalent of a private placement. It is a private and unlisted bilateral loan agreement. Its benefits are similar to a US private placement: competitive pricing, longer tenures, accessible to smaller borrowers, diversification of lender base and no formal rating requirement. In line with the general shift away from traditional bank loans, corporate Schuldschein issuance increased to nearly 13.6bn in 212 (up 14% compared to 211). Schuldschein were traditionally issued by German companies. However the market has recently attracted international borrowers such as Clariant (Switzerland), Huhtamaki (Finland), Sonepar (France) and Sainsbury s (UK). Total 212 issuance by non-german companies increased to 5.bn (up 356% compared to 211). The majority of investors in this market are still German banks and insurance companies but international investors are taking a close look at the market. 212 saw a deal by Neopost being placed with Taiwanese investors and saw Societe Generale team up with German banks to arrange Schuldschein for French borrowers Plastic Omnium and Orpea. 4
Debt & Capital Advisory Nick Atkinson +44 ()27 213 4113 nick.a.atkinson@uk.pwc.com Barry Ross Tel: +44 ()27 213 14 barry.ross@uk.pwc.com David Godbee +44 ()27 213 411 david.k.godbee@uk.pwc.com Jason Green +44 ()27 212 2535 jason.green@uk.pwc.com John Williams Tel: +44 ()27 213 4115 john.g.williams@uk.pwc.com Daniel Judenhahn Germany Tel: +49 ()69 9585-6976 daniel.judenhahn@de.pwc.com Lars Johansson Norway Tel: +47 4816 1792 lars.x.johansson@no.pwc.com Christer Bois Sweden Tel: +46 () 1 212 6296 christer.bois@se.pwc.com Steve Russell Tel: +44 ()27 212 5334 steve.j.russell@uk.pwc.com Steen Soborg Andersen Denmark Tel: + 45 () 3945 9736 steen.soborg.andersen@dk.pwc.com Gianandrea Perco Italy Tel: +39 2 864 6434 gianandrea.perco@it.pwc.com António Rodrigues Portugal Tel: +351 91 359 939 antonio.rodrigues@pt.pwc.com Martin Frey Switzerland Tel: +41 58 792 15 37 martin.frey@ch.pwc.com Gavin Stoner Tel: +44 ()27 212 353 gavin.stoner@uk.pwc.com Herve Colson France Tel: +33 ()1 5657 621 herve.colson@fr.pwc.com Martijn Mouwen Netherlands Tel: + 31 () 88 792 6623 martijn.mouwen@nl.pwc.com Luis-Felipe Castellanos Spain Tel: +34 91568445 luis.felipe.castellanos@es.pwc.com Serhat Acarturk Turkey Tel: +9 212 355 5858 serhat.acarturk@tr.pwc.com www.pwc.co.uk/debtandcapitaladvisory This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, does not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it. 213. All rights reserved. refers to the network and/or one or more of its member firms, each of which is a separate legal entity. Please see www.pwc.com/structure for further details. 13611-163522-PS-UK 5