Bond markets: Resilience underscores European HY maturity
Bankers upbeat on issuance; inflows diverge with US.
Resilience in the European high-yield market during the sell-off in August has raised hopes for more issuance this autumn, with bankers gaining solace from what they see as an increasingly mature market.
There are still a lot of European companies issuing high yield bonds for the first time
Less exposure to oil and gas and metals and mining is partly behind expectations that Europe’s high-yield dynamics could further diverge from the US, given the new dip in commodity prices over the summer. While the fall in the oil price could be beneficial for consumer-related credits in both regions, resources names make up around a quarter of the US high-yield bond market, compared to only around 5% in Europe, according to Fitch.
“Five years ago a sell-off like we saw in August would have shut down the market for weeks or even months,” says Jeff Bennett, HSBC’s head of European high yield. “The European high-yield bond market has reached a stage where it can take events like this in its stride, reprice, and move on.”
Denis Coleman, head of European credit finance at Goldman Sachs, says the longer-term European trend for bond markets to replace bank finance is continuing. “There are still a lot of European companies issuing high yield bonds for the first time,” he says. “Issuance volumes continue to be robust and increasingly relevant globally.”
European high-yield bond issuance reached a record $156 billion last year, according to Dealogic. European leveraged loan volumes also reached their highest levels since 2007 at $312 billion. By contrast, high-yield bond issuance in the US peaked in 2012.
In the first quarter of this year, European high-yield bond issuance was up again on the same period in 2014. The scare over a Greek exit from the euro meant issuance in the US held up better in May and June, but what CreditSights said was a record weekly volume of European high yield issuance in late July, shortly before the annual summer lull, has fuelled fresh hopes for the autumn.
Bankers say 2015 volumes could still come close to, or even beat, last year’s record. HSBC’s Bennett points to relatively weak issuance in the fourth quarter of last year, triggered in part by the initial oil crash. With less pessimism this year over Europe’s economy, issuance between September and December could make up for lower volumes in the second quarter, he says.
“The fundamental drivers of why high-yield bonds are attractive for issuers are still there,” Bennett says. “We might not get to the all-time low spreads we saw in 2014 or the first quarter of this year, but if you think rates will go up in the UK and eventually in Europe, it’s still not a bad time to be locking in long-term debt.”
Bankers say the sell-off in global markets in August means a post-holiday market reopening would be less of a pent-up flood than a case of high grade names testing appetite, before higher quality sub-investment grade names follow. Initially, they say, must-do financings for corporate M&A and leveraged buy-outs will be more numerous than deals by opportunistic issuers seeking to take advantage of low rates – though no one speaks of a complete closure.
From now on, the gains will be more difficult,
Ed Eyerman, Fitch
Coleman points out that August is usually quiet, so the timing of the sell-off meant issuance was less disrupted. He says the global sell-off might mean an overdue correction in the European high-yield market, with more realistic spreads, but says it is possible that for example, Italian and Spanish real estate companies tap the high-yield bond market later this year.
Nevertheless, there is still a worry that some companies’ readiness to take advantage of investors’ search for yield could be storing up troubles that will re-emerge in another downturn. Ed Eyerman, head of European leveraged finance at Fitch, points to secured debt refinanced in unsecured structures, and with lower coupons. “It’s already quite late in the European high-yield cycle. From now on, the gains will be more difficult, and the exposure to losses will be higher.”
One sign of continued potential for growth in European high-yield bonds, even as US issuance has slowed, could be the launch last month of a new bond fund by BlackRock, the world’s biggest asset manager. Benchmarked against Barclays’ Pan-European High Yield 3% Issuer Constrained Index, it has the ability to invest down to CCC and unrated names.
European high-yield bond funds saw inflows for five of the first six months of this year, according to Lipper, while US high-yield funds only saw three months of inflows and deeper outflows during negative months.
“With risk-free yields close to historically low levels, investors are increasingly looking beyond traditional sources of fixed income,” says Michael Phelps, BlackRock’s head of European fundamental credit.
In Phelps’ view, neither the oil rout, nor developments in China, will affect default rates in Europe. “We expect default rates in European high yield to remain low, as companies benefit from having termed out maturities, the improving macroeconomic environment and relatively low levels of leverage,” Phelps says.
He says the fund’s biggest allocations over the benchmark are telecoms, media and technology, and British pubs. It is underweight capital goods, cyclical consumer names and basic materials.