European dealmakers face fewer debt options amid recession risks
European dealmakers are struggling to finance corporate takeovers as concern that the region's economies may dip into recession is prompting debt investors to demand bigger rewards for the risks, they're taking to get deals over the line.
Global economic uncertainty and market volatility triggered by the Russia-Ukraine war, coupled with monetary tightening from the Federal Reserve and the Bank of England and expectations the European Central Bank will follow suit, have made deal financing costlier and harder to access, bankers and analysts say.
More than $390 billion worth of M&A deals have been announced in Europe since January compared to $365 billion in the same period last year - almost doubling 2019 volumes of $199 billion in the same pre-pandemic window, according to Refinitiv data.
While banks have agreed to provide the necessary financing, some are having to sweeten terms to find lenders willing to take on chunks of their debt.
"There are many variables in the market and investors will be careful until these settles and the bid/ask gap tightens, especially in Europe," said Anthony Diamandakis, global co-head of Citi's asset managers franchise worldwide.
"We are not seeing many new debt commitments at the moment because the M&A deal volume feels light."
Global corporate debt yields have soared nearly 200 basis points on average this year. Those on euro-denominated high-yield bonds have doubled to 5.5 per cent, ICE BofA indexes show.
Dealmakers say the financing struggle has not marked a death sentence for new deals, and while M&A volumes are currently subdued, they could still recover later this year.
But in the meantime some debt sales have run into trouble.
In Britain, supermarket chain Morissons' 7-billion-pound ($8.6 billion) takeover by US buyout fund CD&R is the most notable deal to have hit a snag as the syndication of its debt pile has been delayed by about six months.
Lead banks who fully shouldered the Morrisons financing are now left with more than 3 billion pounds of debt yet to be syndicated, one source familiar with the discussions said.
The banks - Goldman Sachs, BNP Paribas, Bank of America and Mizuho - had to place a chunk of its debt worth about 1 billion pounds at a discount of around 10 per cent to be able to sell it to private lenders, the source said.
Goldman Sachs and CD&R declined to comment while Morrisons and the other banks were not immediately available. M&A financing packages are usually underwritten months in advance. Investment banks guarantee a certain interest rate to prospective buyers but also include so-called "flex" provisions in the deal terms allowing them to adjust the final pricing by a certain amount if markets move significantly.
If those are not enough to cover the increase in market rates, the debt gets syndicated at deep discounts with banks making up the difference, which may lead to a loss if it exceeds their fees.
Leveraged buyouts came under increasing scrutiny after the financial crisis as they are typically funded by loading a significant amount of debt onto the target company against its assets. Because of their high debt/equity ratio, they often involve the issuance of non-investment grade high yield bonds, often dubbed junk bonds as they carry a higher risk of default.
But money is fleeing the asset class this year; European high yield retail funds have suffered $20 billion of outflows, or 6 per cent of assets under management, according to BofA citing EPFR data. "A lot of fixed rate high yield investors have cash today, but are worried about outflows. As long as that worry is out there it's going to be difficult to price sizable new deals," said Daniel Rudnicki Schlumberger, head of EMEA leveraged finance at JPMorgan.
Global high yield bond issuance is down 77 per cent since the start of the year, Refinitiv data shows, with European volumes down nearly 75 per cent compared to last year.
After a 10-week shutdown of the European high yield market, the longest since 2009, a pool of banks led by HSBC and Barclays launched an 815 million pound bond sale in April to fund Apollo's takeover of British homebuilder Miller Homes.