European high yield: Abengoa highlights risks amid yield hunt

By:
Dominic O’Neill
Published on:

Spanish infrastructure credits trade down; money continues to flow.

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Abengoa's Solúcar Complex, Seville
Abengoa has given investors in European high yield bonds a wake-up call after filing for creditor protection. Under Spanish bankruptcy law, the Seville-based infrastructure firm has four months to refinance itself in a pre-insolvency period, though the filing will already trigger payouts to some CDS holders, according to an Isda ruling in December.

Its move comes after fellow Spanish firm Gonvarri pulled out of an agreement to subscribe to a rights issue, reportedly because Abengoa failed to gain new bank credit. Abengoa bonds sank below 20c on the euro on the news of the filing. With around €7.7 billion of debt, including bonds maturing every year for the next six years, it could be Spain’s biggest-ever corporate bankruptcy, according to TwentyFour Asset Management.

Abengoa has highlighted how some smaller peripheral European companies have funded rapid growth thanks to easy bond market conditions, even as local banks have pulled back. "High yield investors have been far too quick to buy into companies they didn’t properly understand," says Tanneguy de Carné, head of high yield capital markets at Société Générale.

Concerns

Analysts think Abengoa’s underlying business is profitable, and its engineering expertise is respected. However, concerns over the firm’s structural complexity, and increasing indebtedness, intensified in late 2015 when investors said it unexpectedly reclassified some bonds as non-recourse. Abengoa’s thousands of joint ventures and subsidiaries make it particularly hard to determine how exactly the debt flows through the group. 

The firm has appointed an adviser (reportedly JPMorgan) on a potential sale of Abengoa Yield, a New York-listed unit containing up-and-running assets. But doubts remain over Abengoa’s ability to find adequate funding, when it failed to do so before. Expected recovery rates vary between 40c and 60c if it survives, and between 20c and 30c if it goes into liquidation, according to TwentyFour. 

The biggest impact so far has been specific to companies which share Abengoa’s geographic and sectoral origins – Spanish infrastructure credits Isolux and OHL, which also fund via project debt, have traded down, for example. "There’s been no contagion to the broader European high-yield market," says de Carné. 

Underlying macro-economic trends in Europe, including more loosening of monetary policy, remain supportive of the market as whole. High-yield bond fund inflows continued in late November, according to fund tracker EPFR. Greek telecoms firm OTE returned to the market with a bond yielding 4.625% around the same time. Investors expect European high-yield bonds to continue to generate returns this year, despite expectations of more destruction in value in US high yield, according to Bank of America Merrill Lynch.

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Nevertheless, default rates are creeping up in Europe, as in the US (see graph). After the market sell-off last summer, investors are more circumspect, and have started to think more about what happens when rates eventually rise in Europe too. Higher-rated credits are trading better, says Jeff Mueller, portfolio manager at Eaton Vance in London. He gives the example of the relative secondary market performance of Swissport’s late November secured and unsecured bonds, rated single-B and CCC respectively.

"Investors need to put money to work, but in the run-up to the end of the year, you’ve seen a reluctance to take more risk," says Mueller.

Despite rapid growth in previous years, in 2015 European high yield issuance volumes fell by around a third by mid-December, according to Dealogic, and de Carné’s team expects a further reduction this year. "The market has taken a more defensive view in the past 18 months," he says. "Corporates that are more than five-times leveraged are seeing a lot more scrutiny compared to six months ago. We’re seeing more appetite for BB-rated names than single-Bs or CCCs."

Abengoa seems likely only to reinforce the tendency towards safer credits in European high yield, which is already more dominated by BB names than the US market. Relying on Abengoa’s single-B rating, however, would hardly have been wise. Indeed, its story has "manifested some of issues", says Mueller, at a time when investors suffering from puny high-grade rates have been "blinded by yield" in a market that is still quite small and young.

Questions

Getting comfortable with the risk and not relying on ratings is especially important in names like Abengoa, which are difficult to understand due to their byzantine corporate structures and non-recourse funding, says Mueller. European markets that used to rely on local banks, and that are still getting used to the more rigorous communication standards of the capital markets, call for even greater care, he says.

"This should make investors take a step back and ask whether they properly understand the credit, whether they have full transparency and trust," says Mueller.

Meanwhile, Abengoa’s fate shows how European firms are exposed to global risks, despite a lower proportion of oil and gas names than the US. Like other Spanish firms, Abengoa stepped up expansion in Latin America after the European crisis, which gave way to a reduction in Spanish renewable energy subsidies. Economic and fiscal contraction in Latin America then followed, particularly Brazil, where the government has had to rein in its ultra-generous state development bank – an important partner for Abengoa.

"Abengoa highlights how a lot of these risks – structural complexity, less creditor-friendly jurisdictions, and exposure to slowing growth in emerging markets – have not been priced in," says Ed Eyerman, head of EMEA leveraged finance at Fitch.