High-yield Q&A: Lloyds' Ian Brown and David Whiteley

unquote": The high-yield window is said to have been open for quite some time now, benefiting the European buyout and refinancing markets. Where do we stand now?

David Whiteley: According to S&P figures for high-yield issuance, we have seen sponsor-backed volume at €14.1bn so far in 2013, as of 28 May. To put things in perspective, issuance stood at €14.5bn for the whole of 2012. Including non-sponsor backed issuance, 2013 already has the second highest annual total at €36.1bn and is expected to surpass the €44.4bn issue seen in 2010, shortly.

So we can safely say that the market is indeed buoyant, with a very liquid investor base eager to put money to work. Besides the appetite from investors, the benefits for a lot of borrowers are also very attractive at the moment, notably when it comes to the lack of covenants and the lack of amortisation.

Ian Brown: Unfortunately, this influx of liquidity doesn't seem to be matched with sufficient opportunities to invest. This is probably the most liquid market we've seen for a number of years, and yet there is a surprising lack of activity, certainly at the larger end.

How much of that liquidity is available to finance new deals, as opposed to refinancings?

DW: A significant portion of the activity seen in 2013 so far is for refinancings. But we are pitching on a number of new deals now and we would always pitch a bond option alongside loans. At the moment, the former is always generating interest – certainly for the larger deals but increasingly in the mid-market as well. So while the bulk of liquidity in the market will go towards refinancings, new deals could go straight to bonds as well.

What are some of the trends, in terms of pricing and terms, that have emerged since the start of the year?

DW: The price differential between loans and bonds has kept narrowing, with the recent example of 6% all-in for a B2 senior secured bond on the IDH offering, which is in line, if not below, where a sterling loan would have priced. S&P data shows that the spread between new issue yields for bonds and loans has diminished over the last 12 months from circa 300 bps to below 200 bps.

IB: The biggest talking point in the market for quite a while has been the portability feature. It used to be the case not long ago that issuing a bond and then wanting to prepay it was incredibly costly. And one of the causes of prepayment was a change of control. Now practically every bond we do comes with the ability to sell the business and not prepay, even over an extended time period, as seen recently on the IDH bond.

The market is in such good shape that it makes sense for sponsors to lock in a flexible and low-cost financing now, and then sell the business, whereas before deals could get a bit nerve-racking with bridges that could get very expensive very quickly if things didn't go according to plan. The ability to put financing in place now and worry about the sale later makes a massive difference in the market.

What types of borrowers are proving popular on the high-yield market at the moment?

DW: Bonds lend themselves more to volatile businesses. For example, one would expect retail businesses to see peaks and troughs in terms of activity. A high-yield bond would work well there: if you do have a little dip in trading that you expect to recover from, you won't be breaching covenants since you wouldn't have any. This would be less of a factor for more stable businesses. The high-yield market also allows riskier deals to access finance, whereas CLOs will have difficulty lending to anything that isn't rated B2 or above. It will require a higher price, but you can move further up the risk chain without seeing liquidity drying up.

IB: That said, the appeal of high-yield is not limited to a specific type of business. One can see a wide range of companies, with various profiles and operating in very different sectors, turning to the high-yield market. Looking at the last 12 months, we have been active in the retail space with New Look and DFS, but also in the insurance sector with Towergate, and we've worked on a couple of deals in the financial sector including Lowell and Cabot.

Where do you see the market going in the coming months? Is the window of opportunity likely to close any time soon?

IB: At the moment we don't see any fundamental change in the underlying conditions. There is still plenty of money coming in, and most of the high-yield funds have got plenty of ammunition left. On the supply side, most of the banks have a decent pipeline of borrowers who are looking to come into the market. And the fact that it has been popular in recent months also drives borrowers who perhaps wouldn't have dreamt of high-yield before to consider it as a viable option.

Going back to pricing, is it fair to consider a scenario whereby coupons start falling so much that bonds are not attractive to investors anymore?

IB: Had you asked us this question 12 months ago, we probably would have said that it couldn't go much below 7%. While in theory there should be a point where the risk/reward ratio is skewed, narrowing that point down remains a tough call.

DW: There is certainly chatter that pricing cannot go much lower without the liquidity starting to fall away and investors perhaps moving on towards equities. The risk they would take on bonds would not be reflected in the price.

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