Demand Stays Strong for European High Yield Bonds

The European high-yield bond market (EHY) has made a robust start to 2014, extending the strong issuance pattern characteristic of 2013 and generating total returns of 0.63% in January, reports Fitch Ratings.

The credit ratings agency (CRA) said that issuance has so far proved resilient in the face of emerging-market (EM) selling pressures as issuers seek to benefit from favourable technicals, with demand for new issues outstripping supply. Volume in January 2014 was only slightly off the pace from a year earlier, with €6.9bn issued.

“New bond volume in 2014 may have difficulty keeping pace with record levels from last year, particularly as a recovering leveraged loan market represents an alternative capital source for borrowers who would otherwise have tapped EHY,” said Ed Eyerman, Fitch’s head of European leveraged finance.

Issuance is, nevertheless, likely to remain well-supported during the year, as legacy issuers respond to all-time low yields by refinancing callable bonds at lower coupons. Loan market borrowers from out-of-favour sectors or regions may additionally find limited appetite for refinancing other than via EHY.

Spreads remain off pre-crisis lows, providing a degree of protection against rising benchmark rates, while bolstering the appeal of EHY relative to US high-yield (USHY). Real economic growth in 2014 will be key for the type of spread compression that can provide meaningful protection from rate rises.

Issuance marked a fresh high in 2013, buoyed by signs of a nascent eurozone recovery and continued yield-seeking investors receiving record inflows. The EHY market grew 23% in 2013 to €574bn, almost double the 12% growth rate experienced in USHY. EHY developed-market (DM) non-financials issued €87bn in new bonds in 2013, surpassing the prior-year volume of €65bn, representing 52% of outstanding volume. Two-thirds of total outstanding volume consisted of BB-rated bonds.

EHY grew more flexible last year as borrowers sought the cheapest deals with the most flexible terms from both European and US debt capital markets. The share of new issues rated ‘B’ or below rose to 37% in 2013 – the highest since 2006 – as investors targeted the more attractive yields from lower-quality bonds. Stronger new issuance is expected from ‘B’- and ‘CCC’-rated entities, in particular subordinated instruments at high multiples of leverage, senior secured bonds from peripheral European entities and legacy leveraged buy-outs (LBOs) from issuers approaching maturity walls in less favoured sectors.

The default rate for December 2013 rose to 1.2%, from 0.7% a year earlier, but remained below its long-run average. EHY remains the favoured asset class in a recent Fitch’s poll of senior European fixed-income investors. The vote of confidence comes despite rising concerns that the asset class is overpriced and against a marginally more pessimistic outlook on fundamentals, issuance and spreads.

EM issuers sold a record €31bn of new bonds in 2013 – two-thirds in 1H13 – while expanding their diversity by geography and industry. Russian issuers continued to dominate – accounting for 45% by new bond volume during the year – but have displayed considerable broadening in industry composition since 2012.

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