European High Yield Bond Market: Spotlight on Southern Europe

HY Bonds – Spotlight on Southern Europe

Economic growth in Southern European countries over the last few months has been the most robust in Europe, with Italy and Spain in particular showing highly attractive growth through an increasing number of M&A deals and related financings (including high yield issuances). Greece and Portugal are soon expected to join this spurt of activity as a result of recent sovereign upgrades in their respective credit ratings. Given Ashurst's strong presence in Southern European jurisdictions (the firm has full service offices in Milan and Madrid that provide broad banking capability in both local and English law, as well as a Greek focus with ongoing Greek bank mandates), we wanted to highlight the recent trends for high yield bonds issued by corporates from Italy, Greece, Spain and Portugal.

Italy

The Italian high yield market exploded over the summer months, with six deals pricing between June and August, namely, Limacorporate, AnaCap, Cooperative Muratori, Kedrion, Manutencoop and NTV) and one deal pricing in September (Almaviva), for a total of nine deals that have already come to market this year. By year-end 2016, Italy represented 17.2% of European high yield issuances, however, we expect Italian bond issuances by year-end 2017 to surpass this proportion . Highlighted below are some of the recent trends we are seeing in the Italian high yield market.

Structure, size, etc. Here are some statistics for the Italian high yield deals over the last 12 months:

• issue size varied from EUR 200m (Gamenet) to over EUR1bn (SNAI)

• a number of issuers with modest EBITDA were able to successfully market their bonds and negotiate good market terms: as low as "adjusted EBITDA" of EUR 50m in the case of Marcolin and "adjusted EBITDA" of EUR 68m (or unadjusted EBITDA EUR 43m) in the case of Almaviva

• roughly 2/3 of the deals were sponsor-backed

• the most active sectors in deal volume were gaming, industrials, financial services and healthcare

• roughly 2/3 of issuances were earmarked for refinancing purposes, with the rest being used to finance acquisitions

• the highest reported leverage was 5.5x (Limacorporate)

• national banks were involved in each deal, with at least one of Unicredit, Mediobanca, Banca IMI or Unione di Banche Italiane acting as an underwriter on each transaction

• one PIK Toggle deal came out of Italy this year (ICBPI) pricing at 7.125%

Rating. Unlike the rest of Europe where BB-rated issuances still dominate the market, every Italian high yield deal that priced in the last 15 months has been single B. We believe this trend will soon spread to other markets as more single B credits come to market. Given the QE buying of the investment-grade credit, in terms of ratings, single B credits are becoming as attractive as BB credits and provide an attractive opportunity to investors in terms of coupon, while still offering good protection. In addition, we find that in the single B area, there is increasing focus on the credit history and the growth story of issuers rather than on the protections provided by the bonds covenant package.

Floating Rate. FRN deals constituted over 50% of all recent deals in Italy, which is noticeably higher than in the broader European market, where they remain a minority. Such a trend is likely due to the fact that many of the comparable deals that would have been structured as loans in other jurisdictions, are executed in a bond form in Italy: whereas regulatory restrictions prevent financiers who do not have an Italian lending license from making loans to Italian corporates, issuing debt in the form of a bond allows Italian issuers full access to international capital.

Favorable borrower terms. Though not universally so, we find that Italian issuers have been able to negotiate documentary terms that are more favourable to the issuer in comparison to other European credits, such as 40% equity claw, short non-call periods (due in part to the high percentage of the FRNs), basket growers (either assets/EBITDA-based - split about 50/50), contribution debt, RPs made with excluded contributions, leverage-based RP basket, leverage-based portability (the latter being found in about half of the Italian deals over the last 12 months).

Italian-law specific provisions.

• In many deals, issuers are permitted to incur privilegio speciale liens under Italian law, which relate to movable assets (including stock and machinery) of the chargor and are loosely analogous to a floating charge under English law; these liens do not affect the power of the chargor to dispose of the charged assets in the ordinary course of business prior to the occurrence of an event of default

• Another interesting legal quirk is that the Italian code provides for a general voting threshold of a simple majority for corporate matters, and it is unclear whether any higher voting threshold would be upheld in court. Historically Italian deals have evolved to require a 75% supermajority voting threshold (whereas in other jurisdictions the typical supermajority threshold is 90%), and to include a risk factor stating that this contractual threshold may be further reduced to a simple majority under Italian law

Greece

On August 18, 2017, Fitch upgraded Greece's sovereign rating from 'CCC' to 'B-', outlook positive. As a result of the general uptick in the Greek economy and the ratings increase, we expect an increased number of Greek issuers compared to recent years.

On the heels of the sovereign rating upgrade, in September, the Greek-based gaming solutions group Intralot priced its single B rated EUR 500m 5.25% senior unsecured notes due 2024 at par. Although the general covenants remained the same, the deal was very well received by the market: it was upsized, priced at the low end of the pricing guidance, with books over 3x oversubscribed. This was an opportunistic refinancing, with the company taking advantage of the favorable market conditions to double the size of its existing bonds and to reduce the pricing by 150 bps compared to the existing bonds, which were issued just a year ago. The company will use the proceeds to keep additional cash on balance sheet.

The other existing Greek high yield issuers also appear to be doing well, with Titan Global and Hellenic Petroleum recently reporting financial results that show strong growth in sales and EBITDA.

Structure, size, etc. Looking at the Greek high yield deals over the last 12 months, the following trends emerge:

• issue size varied from EUR 250m (Titan Global, Wind Hellas, Intralot, 2016) to EUR500m (Intralot, 2017)

• issuer's EBITDA was as low as EUR 92m (Wind Hellas)

•  similar to the Italian issuers (but unlike the rest of the European high yield space), the Greek issuers also tend to be single B rated (or even unrated/private placements)

• most issuances were made through an English plc entity (opting for a holding structure in a jurisdiction that the investors are familiar and comfortable with)

• there were no sponsor-backed deals; all issuers were either publicly listed on the Athens Stock Exchange, widely held, or family-owned

• the most active sectors in terms of deal volume were oil and gas and gaming

• in all deals, proceeds were used for refinancing purposes, with the exception of Intralot, 2017, which took advantage of favorable market conditions to pay off the more expensive notes from last year and kept the rest on the balance sheet (note: the proceeds of the previous, 2016, issuance were used by Intralot to redeem the existing notes)

• the highest reported leverage was 3.1x (Intralot)

• national banks were not particularly involved, with only two Greek banks appearing among the eight initial purchasers in the Motor Oil transaction and no Greek bank taking a bookrunner role in the other transactions

• most of the bonds are unsecured (possibly because it is generally difficult to enforce security in Greece)

High Yield-Lite. Interestingly, two of the recent Greek deals (Titan Global and Hellenic Petroleum) are so-called "high yield-lite", i.e., they are non-call for life, have a change of control put at 100% (vs. the customary 101%) and have an investment grade-style suite of covenants limited to the negative pledge only. This could be because these corporates would have been investment-grade rated but for Greece's sovereign debt rating at the time of issuance. As a counterbalance, one of these deals (Hellenic Petroleum) has a mandatory redemption put event if the ratio of debt to consolidated net worth exceeds 1:1 (subject to a ratings trigger).

Spain and Portugal

It is safe to say that the slump in the Spanish high yield market caused by the downturn in the Spanish economy and high-profile restructurings of the Spanish issuers such as Abengoa and Codere is coming to conclusion. A resurgent Spanish economy, coupled with Spanish banks cutting costs aggressively in their search for deals, is creating significant activity in the market.

Most recently, in September, the Spanish retailer Cortefiel issued EUR 600m of notes split between the fixed and floating rate tranches, with the notes receiving an enthusiastic reception in the market, pricing tighter than official price talk and the non-call period on the fixed rate tranche being reduced by one year to non-call two.

Structure, size, etc. The following observations can be made about the Spanish high yield deals over the last 12 months:

• issue size varied from EUR 232m (Naviera Armas) to EUR 1bn (Grifols)

• issuer's EBITDA was as low as EUR 55m (Naviera Armas)

• the majority of the deals were sponsor-backed deals (backed by the likes of CVC, Permira, Ardian, Silver Point); the remaining issuers were for the most part family-owned

• the most active sectors were hospitality, transportation and gaming

• all the deals used proceeds for refinancing

• the highest reported leverage was 4.7x (Grifols)

• national banks (BBVA, Santander, Banca March, Banco Sabadell, BANKIA, Bankinter, CaixaBank) were active on almost every deal

• a PIK Toggle deal (Allfunds) priced in July at only 4.125% (cash interest)/4.875% (PIK)

Generally tighter terms. Spanish issuers tend to get less permissive/more conservative terms as compared to the broader European high yield market and to their Italian counterparts in particular. For example:

• while portability is making a comeback in the rest of Europe, in Spain it is found in only one deal

• FCCR level for ratio debt is set at a tighter 2.25-2.5x in a number of deals (versus the standard 2x)

• grower baskets (if any) are based on the percentage of total assets (versus the more permissive percentage of EBITDA)

• acquisition debt is not expressly permitted in at least half of the deals (though acquisition debt could still be incurred utilizing other baskets such as ratio debt and general basket)

• contribution debt is only permitted in about half of the deals (whereas it has become more prevalent in other European markets)

• designated non-cash consideration concept is not present in about half of the deals (whereas it has become more prevalent in other European markets)

Portugal. Finally just a few words on Portugal. Although there have been no new Portuguese high yield issuances since 2015 and most existing Portuguese issuers are concentrated in the TMT sector (with a crop of deals from Altice, Oi, Portugal Telecom), we anticipate this is about to change. The country's economy has been on the upward trajectory, which culminated, most recently on September 15, 2017 with an upgrade for the sovereign credit rating on the Republic of Portugal to 'BBB-/A-3' from 'BB+/B' with stable outlook. This is a jurisdiction to watch.