(Bloomberg) -- Goldman Sachs Group Inc. and BlackRock Inc. predict Europe’s most indebted companies will shift their money raising toward bonds and reduce reliance on loans in the post pandemic world, echoing the last financial crisis.
The move to bonds will largely reflect investor demand as fixed income funds have seen seven consecutive weeks of inflows since the credit-market crash earlier this year. At the same time, issuance of collateralized loan obligations -- bonds backed by leveraged debt -- has slowed to a trickle, hobbling a market that typically absorbs half of new loans to European companies.
“Steadily we’re going to see an increase in issuance, and a number of companies that have relied more on the loan space will look to access high yield bonds,” said Michael Marsh, head of credit finance for Europe, the Middle East and Africa at Goldman Sachs. “The bond market is a little more robust right now, it’s less constrained than the loan market.”
Recent deals suggest the trend has already started. Two borrowers that have made previous use of both markets -- BMC Software Inc. and Merlin Entertainments Ltd. -- raised bonds in preference to loans in recent weeks.
It’s a change from the pre-Covid market when a healthy CLO market drove loan demand. Only eight new European CLOs have priced since the start of March, the same number often seen in a single month until recently.
More Diversity
Another driver of the switch to bonds is the deteriorating credit quality of corporate borrowers following the economic shock of a global pandemic. S&P Global Ratings had cut the credit scores on 173 issuers in the EMEA region by May 20 since the start of the current crisis.
A rising number of firms being stripped of their investment-grade status will contribute to the net supply of high-yield bonds outpacing loans this year, according to research by Barclays Plc. The bank now forecasts the volume of available bonds in 2020 will increase by between 40 billion euros and 45 billion euros, up from the 35 billion euros it originally predicted. Loan supply will rise by 20 billion euros, down from the previously expected 30 billion euros.
Corporate borrowers that have suffered a downgrade on account of pressures on their business from the pandemic may find the bond market more receptive than loans because it’s bigger, with a more diverse investor base.
“Lower-rated borrowers are more likely to choose bonds as the more diverse return profiles of bond investors makes it easier to find a price for the risk,” said James Turner, who heads European leveraged finance at BlackRock, overseeing bond, loan and CLO strategies.
“European borrowers can alternate between loans and high-yield bonds, but during times of stress, issuers can lean more heavily on the high-yield market.”
The shift may hand more power to investors. Loans have a flexibility that can play to the advantage of borrowers because they can be easily repaid or repriced if the issuer thinks it can get a better deal. But bonds’ usually have a non-call period written into their structure. This allows investors to lock in coupons for several years without the risk of getting repaid and offered new debt with worse terms as soon as conditions improve for the borrower.
That’s a valuable feature in today’s market, so much so that some companies raising loans are adopting it. Apcoa Parking AG, for example, which can’t repay its new loan for one year.
Some companies are still choosing loans. Insurance broker Financiere CEP SASU launched a 725 million-euro buyout loan this week and others are raising small liquidity facilities. And bonds may not suit those with urgent financing needs that have never yet tapped that market, since it can take first-timers around two months to prepare accounts and documentation.
But for those that need large sums of money whether for acquisitions, refinancing or to boost liquidity, raising as much as possible from high-yield could be the best option.
“Arrangers will be thinking about market capacity. If the company can raise dollars or euro high-yield bonds, that’s helpful as the European loan market has taken the longest to recover,” said Sarah Mackey, EMEA head of leveraged capital markets at UBS Group AG.
©2020 Bloomberg L.P.
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