The pace of new issue activity in Europe's nascent high yield markets is still more akin to the snail than the hare. And its range of credits lacks diversity, with investors keen to buy paper outside the start-up telecoms sector.
However, the high yield euro capital markets showed a surprising resilience during the credit market turmoil of late 1998. Spreads quickly recovered as the markets calmed.
Is this new robustness, and the growing number of investors dedicating funds to the high yield sector, a sign that the market will at last make the move from nascent to fully fledged? Eugénie Ballara reports.
The speedy recovery of Europe's high yield corporate debt market following the collapse of the credit markets in the autumn of 1998 surprised even the most optimistic of market participants.
The high yield market had long been trumpeted as Europe's hottest new asset class, but fell dramatically - with other low grade markets - when the correction hit. But with supply and demand side forces continuing to stimulate its development, the speculative grade market in Europe has resumed steady growth.
Indeed, some bankers say the credit market's collapse has left the high yield market stronger and more healthy than before.
"The crisis of October was beneficial because it cleansed some of the non-longer term players out of the market and those that survived have seen the worst," say Geoffrey Sherry, managing director and head of European high yield trading and capital markets at Chase Manhattan. "The European high yield market is healthier, broader and deeper than was the case last October."
Secondary market spreads recovered following the upheaval at the end of last year. By the end of May the Chase Manhattan CSI High Yield Index stood at 535bp over Treasuries, down from a high of 764bp over on October 16, 1998.
The new issue market has taken longer to pick up steam, but is now entering one of its busiest periods yet with sizeable multi tranche issues recently launched for KPNQwest, American Standard and Orange.
Investors are happy to see a healthy pipeline of new issues after a long hiatus. "The amount of supply in the new issue market is building up now and although it is small compared to the US, it is still quite a lot of paper relative to the size of the market," say James Gledhill, a high yield fund manager at M&G.
"It's a typical London bus syndrome -they all come at once - but I'm really quite pleased," says Gledhill. "For the first time in the last few months we are seeing supply catching up with demand."
Media and telecommunications companies, with their voracious appetite for capital, still account for a large proportion of supply but the market is also welcoming borrowers from other industry sectors, often via LBO financings.
M&A-linked transactions have played a major role in the development of the high yield market in Europe, as they did in the US. Two such deals have been launched this year - for Willis Corroon and Coral - and the forward calendar is full of high profile M&A financings.
The $550m 10 year issue for Willis Corroon, the first high yield deal of 1999, refinanced a bridge loan partially funding the acquisition of the insurance broker by Trinity Acquisitions, a company formed by equity sponsor KKR and five insurance companies.
It was the first insurance name in the European market and its industry sector was a key selling point for investors keen to diversify their high yield holdings. Despite being denominated in dollars the transaction saw extremely strong European demand.
Coral's £80m 10 year issue - financing Morgan Grenfell Private Equity's £390m leveraged buy out of UK bookmaker Coral from Ladbrokes at the end of 1998 - was another success story coming at a time of strong demand in the sterling high yield market.
LBO-linked issues in the pipeline include: a $535m issue for Zeneca Specialty Chemicals, which partly finances the record breaking $2.1bn MBO of the specialty chemical unit of AstraZeneca by Cinven and Investcorp; a $800m issue for HICH, a company comprising former assets of US company Huntsman and the UK's ICI; and a Eu100m issue for Leica Geosystems.
The long awaited corporate restructuring in Europe will continue to be a strong influence behind the supply side of the market, say participants.
"The big driver of non-telecom issuance has been and will continue to be LBOs," says Sherry. "Down the road we will begin to see more classic corporate high yield bonds but it will take a while for corporate Europe to embrace high yield as a way of financing."
A few straightforward corporate financings have come to the market this year including issues for industrial companies Tokheim, Luxfer and Doncasters.
Lead managed by Bankers Trust, Tokheim's dual currency dollar/euro issue was the first high yield bond to be launched in the single currency and the lack of good quality industrial names ensured its success.
Sterling issues for Luxfer and Doncasters also enjoyed a warm reception from investors happy to see non-telecom names in the market.
But despite demand for non-telco paper, media companies and telcos have continued to dominate the new issue supply in 1999, accounting for more than 50% of new issue volume according to Capital Data Bondware.
The market has welcomed both early stage telcos as well as more established names such as NTL and Telewest, which have both returned to the European high yield market this year. Orange recently made its second foray into the European high yield market with a three tranche £460m offering - which, despite softer market conditions, was increased on the back of strong demand. Although keen to buy new industry sectors, investors have lapped up most of the media and telecommunications paper that has come the market.
"Although everyone wants a nice double-B industrial name the telco stories are still very attractive," says Thomas Crawley, head of European credit research at Salomon Smith Barney. "It is a high growth industry with lots of potential, so while investors may have a high exposure to telcos it's not a bad market to be exposed to."
Investors are now familiar with the industry, a fact that helps them to analyse new credits. Many companies such as NTL and Telewest have a relatively long history of high yield issuance, a familiarity that eases the passage to market of new names from the same sector.
Spanish start-up cable telephony company Cableuropa is one such example. Despite a rating at the lower end of the credit spectrum its first high yield bond offering, launched at the end of April, met strong demand and its total size was upped from Eu300m to Eu407m.
"The issue saw better than expected US and European demand," says Jonathan Turnbull, co-head of European high yield capital markets at Salomon Smith Barney. "People were interested in the credit which is very much like UK cable companies but based in Spain. UK cable companies have been among the largest issuers of high yield debt in the last five years so investors felt comfortable with the story."
Turnbull explains: "It is much easier when you can show people something they understand."
Competitive local exchange carrier Tele 1 Europe achieved similar success. Lead managed by Lehman Brothers, the issue was upped during the roadshow and was finally launched at the larger end of expectations as a dual currency issue comprising $150m and Eu100m tranches.
While investors want to see a diverse industry spectrum, they also need exposure to a range of credit ratings. Early issuance this year was dominated by single-B names and investors have been keen to add higher rated credits to their portfolios.
The lack of double-B rated names ensured success for the large multi tranche issues for US manufacturer American Standard and telecoms joint venture KPNQwest. Despite coming at a time of widening spreads in the secondary market both transactions were successfully priced and traded above par following launch.
Lead managed by Goldman Sachs, the 10 year transaction for KPNQwest was increased from the initially planned $750m equivalent to $810m. All the excess demand was absorbed by the euro tranche which, at Eu340m, ranks as the largest euro denominated high yield bond issue to date.
Robust demand for euro denominated product also allowed American Standard to increase the euro tranches of its $464m equivalent deal to Eu250m, although this was done at the expense of the sterling issue, which was reduced to £60m from the initially planned £100m.
The euro has won a healthy share of high yield business in its first five months of existence, accounting for over a third of new issuance according to Capital Data Bondware. Its success is to some extent at the expense of the sterling market, which now accounts for just 20% of the new issue market.
With the sterling high yield market dominated by a finite group of investors the strength of demand is heavily dictated by the ebb and flow of cash into UK funds, according to bankers. The last minute rush to buy Peps helped drive demand for sterling denominated bonds in March, but since then demand has dropped back.
A softer sterling sector impacted on the new issue market with the scaling back of two sterling issues launched in May. They were the sterling tranche of American Standard and the £50m issue for golf club operator Clubhaus, which had initially planned to bring a £60m transaction.
The Clubhaus deal, lead managed by Bankers Trust, was cut back because the issuer did not want to pay the coupon levels demanded by the market at the time of launch.
Priced at the end of May, it came outside early price talk to emerge with a 13% yield. Had the company come a month earlier it could have got away with a significantly lower coupon, according to market participants.
Since its introduction the euro has become the currency of choice for most European high yield investors. And the new currency looks set to take an ever increasing share of high yield issuance.
Not only has the emergence of the single currency created a large pool of investment capital in Europe, it also brought with it the convergence of interest rates and low yields across the continent. Faced with a low-yield environment, European funds have had to look for more creative ways of obtaining returns.
In increasing numbers, these investors are looking at the high yield asset class as a way to increase yield. As a result, the number of banks getting involved in the market is also rising.
"A year ago there were about five to six banks involved in the high yield market and now there are about 15," says one market participant.
"The increase on the client side has been even larger. About six to seven UK investors were looking at the market back in October and now there about 30. We have seen a similar increase in France and Germany as well."
The size and number of dedicated high yield funds is certainly growing. M&G, which was one of the first UK fund managers to set up a high yield fund, recently announced that the fund has grown from £32m to £340m since October.
Meanwhile, fund manager Invesco has announced plans to set up a European high yield fund denominated in sterling and, possibly at a later stage, a fund denominated in euros.
More widespread participation in the high yield market by the likes of pension funds and insurance companies will take longer, say market participants.
"The challenge is to get insurance companies and pension funds which we would traditionally think of as conservative money managers starting to look at below investment grade bonds," says Sherry.
Finding the credit expertise can be another hurdle for European institutions keen to participate in the market. While some have started to hire credit analysts another option may be to farm it out to high yield fund managers.
Although European demand for high yield bonds is growing, US high yield investors remain a major force in the market, driving demand for the dollar denominated issuance and often determining pricing on a deal.
"US investors are still very important for the European market. Some of the big deals wouldn't get done without US support. European accounts have very strong cashflows but they don't have the big capital base of the US funds," says one banker, who adds that the growth of the European market also represents an opportunity for US funds to diversify their portfolios.
"The focus of US portfolios is the US economy and so they are keen to buy something which diversifies their geographical exposure. And by buying European currency bonds they can typically pick up spread as well," the banker says.
The higher spreads on European currency issues over those available in the dollar market reflects a liquidity premium which comes with having a smaller investor base and a smaller number of market-makers.
US demand for non-dollar high yield securities has increased significantly, say participants, but despite higher spreads not all US investors can or want to buy foreign currency issues. Some may buy euro denominated issues and swap their holdings, but not all can hold swap structures and others may not want to.
"The US investors that can hold the swap instrument will and should do so, but the number who do that is finite. If it wasn't we would see the spreads converge," says Salomon's Turnbull.
But market participants describe the spread differential as a 'honeymoon period' for European investors that cannot last forever - an anomaly that will gradually fade as the European market continues to deepen.