Fitch says European high-yield issuance hits record €30.7 billion

By Angela McDaniels

Seattle, Oct. 19 - Fitch Ratings said that year-to-date European high-yield issuance of €30.7 billion has eclipsed the €26 billion recorded during the whole of 2005 and establishes a new record for annual issuance.

The agency said market growth has been supported by signs of greater accommodation and flexibility from high-yield investors in meeting the demands of corporate and financial sponsors, particularly in terms of accepting greater call risk in floating-rate structures and more flexible covenants.

Large leveraged corporate acquisitions and large private equity-sponsored buyouts have driven over two-thirds of high-yield issuance this year, compared with only one-third in 2005 when the market was more dependent on corporate refinancing activity and cable issuers, according to an agency release.

"An increase in acquisition-related debt incurred by already leveraged issuers has resulted in higher risk in the European high-yield market," Matthias Volkmer, associate director in Fitch's leveraged finance team, said in the release.

In the third quarter of 2006, the proportion of instruments rated CCC+ and below increased by €2 billion to €12.9 billion, or 9.5% of outstanding issues. Fitch said the shift was driven by a number of low-rated issues from Treofan Germany GmbH & Co. KG, VNU NV, TDS and Impress Holdings BV and by downgraded volumes relating to issues from Dura Automotive Systems, Inc., Schefenacker AG and Damovo Group SA, among others.

Jumbo transactions

Despite the seasonal slowdown in the third quarter, strong merger and acquisition activity generated a number of jumbo transactions for the European high-yield market:

• In July, Linde AG issued €1.06 billion equivalent of hybrid bonds to partly fund the takeover of its British peer BOC Group plc;

• In July, NTL Cable plc issued €550 million equivalent of notes to complete the financing of its merger with Telewest Communications plc and the acquisition of Virgin Mobile Holdings plc;

• In August, VNU issued $1.67 billion equivalent in bonds to partly fund its leveraged buyout; and

• In September, Impress Holdings issued €753 million equivalent of senior secured floating-rate notes and €250 million of senior subordinated notes to fund the group's recent acquisitions in the United States and Europe.

Fitch said issuance of €5.2 billion in the third quarter was followed in early October by a record €4.5 billion multi-tranche combination of senior secured floating-rate notes and subordinated fixed-rate notes by NXP BV to fund the leveraged buyout of Philips Electronics' semiconductor unit, a €500 million refinancing by Softbank Corp. and a €1.1 billion high-yield refinancing from Rhodia SA, which boosted total issuance to €30.7 billion for the year to date.

With the remaining pipeline of roughly €1.22 billion that the agency expects to materialize in the fourth quarter - including €725 million by TNT Logistics, €345 million by Carson Wagonlit BV and €150 million by Algeco/Elliot - total European high-yield issuance could total €31.9 billion by the end of the year, up from the €26 billion recorded in 2005. This would also surpass the €29.3 billion in 2004 and €23.9 billion in 2003 and could constitute a record year for European high yield.

Mezzanine debt pressure

Despite strong year-over-year growth in high-yield issuance, Fitch said private mezzanine instruments continue to exert substitution pressure on bond volumes.

The third quarter saw the largest ever mezzanine tranche of €1 billion in support of the cable merger between Multikabel BV, Casema BV and Kabelcom, an amount which until recently was the preserve of the high-yield market.

While the number of high-yield issuers remained similar with 56 issuers in the first nine months of 2006 - compared with 59 during the same period last year - the average volume per issuer increased to €432 million from €416 million in the second quarter, €325 million at the end of 2005 and €262 million at the end of 2004.

The agency said this reflects the ongoing shift toward jumbo-size high-yield issuance, as smaller transactions continue to be financed by combinations of stretched senior and jumbo mezzanine debt. Taking the October issuance into account, the average volume per issuer in the year to date would have been €520 million.

Defaults stable

The trailing-12-month default rate remained stable at 0.3%, Fitch said, because no further defaults occurred in the third quarter. However, the agency predicted that the current rate could double to 0.6% if troubled issuers Damovo and Dura were to default in the fourth quarter.

Last week, Damovo announced that its Italian business was experiencing problems with short-term impact on its working capital and that it was considering a deferral of the interest payment due on Oct. 30 on its €358 million notes due 2012, according to the release.

On the same day, Dura informed its lenders that its debtor-in-possession financing requirements had increased due to lower-than-anticipated operating cash flow. The company then announced on Oct. 16 that it would not make an interest payment due on its $400 million notes due in 2012. Following the potential default after 30-day-grace-period, this could result in a cross default on Dura's outstanding €100 million notes, whose next coupon payment is due on Nov. 1.

In addition, bonds for Schefenacker and Focus trade at a deep discount, and advisers have reportedly been hired to support balance sheet restructurings, which the agency said could potentially add to the default statistics by the end of 2006 or 2007.

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