Regeneration of European high-yield market progressing more slowly than U.S. comeback

By Jennifer Lanning Drey

Portland, Ore., Oct. 9 - The primary market for U.S. high-yield bonds is picking up speed on the road to recovery following the shutdown that resulted from the summer's market dislocation; however, the revival of its European counterpart is lagging by comparison.

The European market hasn't had a deal placed since July 23 when InterGen NV priced an offering for its 8½% senior secured notes due 2017.

The drought in the U.S. market ended more than three weeks ago, on Sept. 17, when Baseline Oil & Gas Corp. priced an offering of five-year senior secured notes via Jefferies & Co. The oil and gas producer's offering priced at a significant discount but nonetheless ended the dry spell and signaled the possibility of a forthcoming revitalization following the period of inactivity that came after the summer's market turmoil.

Markets in both the United States and Europe continue to deal with decreased liquidity and heightened investor trepidation. Accordingly, central banks on both sides of the Atlantic stepped in last month and provided cash infusions aimed at boosting liquidity and increasing investor confidence in the system.

However, the signs of regeneration that have since showed up on the U.S. side are not yet visible in Europe.

A number of factors may be contributing to the lack of deals coming into the European market, but sources agreed that a large portion of the disparity between the activity levels in the U.S. and European markets could simply be attributed to their differing sizes.

As a significantly smaller market, Europe doesn't have the burgeoning pipeline that the United States holds, nor does it have a constant queue of corporates that need to use it, sources in Europe said.

"The corporate sector in high yield in Europe is smaller than in the States, and most corporates in Europe have refinanced in the last few years," said one Europe-based source who is involved in the high-yield market.

Additionally, growth during the first half of the year for the European market was fueled by leveraging strategies including merger and acquisition and leveraged buyout financing related to the mega deals that are now likely a thing of the past, which means a forthcoming recovery there could be further delayed.

High-yield bond issuance volume totaled €33.5 billion through the first half of 2007 in the European market, an amount that was 81.1% higher than in the first half of 2006, according to a European High Yield Association summer report.

The increase was driven by the first half of the year's sustained economic growth, higher corporate profits, business investment and expansion, employment, consumer gains and historically low interest rates, the report said.

European high-yield bond and leveraged loan indices registered positive returns through the second quarter on a trailing 12-month basis.

True reopening?

The reopening of the high-yield market in the U.S. has mainly been fueled by corporate names that are well known in the market and offer a low level of uncertainty with regard to their credit, one high-yield syndicate official in Europe said.

The rest of the recent issuers in the U.S. market have been desperate and had no place else to go.

The difference in Europe is that there simply aren't as many well-established corporates that are able to bring forward deals in more uncertain times. Instead, the newer high-yield market lends itself toward first-time issuers that have not yet established a track record and are unlikely to price a deal when investor confidence may be waning, unless they absolutely have to.

"There's definitely some deals in the pipeline, but lots have not seen the light of day because they are not low-leveraged, easy-to-swallow businesses," the Europe-based high-yield source said.

Additionally, many potential issuers have already recently refinanced or have their finances in line enough to be able to wait for better market conditions, so there isn't the same contingent of desperate issuers in the European market as there is in the United States, the high-yield syndicate official said.

Fewer dedicated investors

The European high-yield market also may be suffering from a lack of committed players, which is natural given its young age and past history.

The European market only traces its roots back to the late 1990s and in its early stages encountered a pretty big bump when markets around the globe were hit by the 2001-2002 downturn.

Meanwhile, a dedicated investor base that has players who have been involved in the high-yield sector for as many as 30 years is aiding activity in the U.S. primary.

Although both markets saw an initial flight to quality following the sudden and often severe losses taken over the summer, the U.S. market has investors that have been through the cycles many times before, while high-yield investors in Europe may need additional signs of economic stability and a clearer picture of the direction of the market before they will invest, sources said.

When the market does return, issuance is expected to initially come from sectors such as health care and energy, which typically garner confidence even during a downturn.

However, there isn't a high volume of companies in those sectors that issue euro-denominated bonds, one source pointed out.

Rate cut factor

One obvious difference between Europe and the United States right now is that the short-term interest rate in the United States has been slashed while in Europe, it has not. However, sources based in Europe were divided on whether the lack of a rate cut is actually a meaningful factor in the European market's slower recovery.

While the high-yield syndicate official said the lack of a rate cut had "zero effect" on market activity in Europe, another euro market participant believed a rate cut could help the market rebound sooner than it would otherwise.

On Oct. 4, the European Central Bank said key interest rates would again remain unchanged, although the market source expected to see a cut when ECB officials meet in November.

In conjunction with the ECB's most recent announcement that the interest rate would remain the same, the bank said information shows the outlook for price stability over the medium term is subject to upside risks and that the fundamentals of the euro-area economy support a favorable medium-term outlook for economic activity.

Some U.S. investor sources have attributed the high-yield market revival in the United States to the investor confidence and liquidity generated in response to the Federal Reserve's decision to reduce interest rates.

The debt overhang in the United States may also still be contributing to lessened investor confidence in Europe because, as one of the Europe-based sources put it, "You can't ignore it."

Deals in the pipeline

Despite investor trepidation in Europe, sources said there are deals in the pipeline for the European market. Multiple sources mentioned Kaufman and Broad SA as planning to price a deal with a euro component this quarter.

One source was also hearing that First Data Corp. and Allison Transmission, Inc. are both considering offering tranches of bonds in Europe and was surprised that nothing has been announced.

Additionally, a deal may be forthcoming from Alexander Forbes Ltd., a financial services company based in South Africa, and a few smaller deals may also price soon, including one from Tiscali Italia, a European telecommunications company.

"I'm not holding my breath," the Europe-based source said after predicting that a deal may price in the next two to three weeks.

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