EMEA Bond Ratings Reflect Recovery in Europe

The rating migration trend of Europe, the Middle East and Africa (EMEA) financial and non-financial corporate bonds may turn positive by year-end as the European economic recovery takes hold, predicts Fitch Ratings.

In its report, entitled
‘EMEA Corporate Bonds: Rating and Issuance Trends’
, the credit ratings agency (CRA) says that the ratio of bond upgrades to downgrades improved 14% in the first quarter of 2014. This continued the narrowing negative bias seen throughout 2013, after having been entrenched in a negative rating migration trend since 2007.

The main risk to a more benign rating trend development lies with the banking segment, says Fitch Many European Union (EU) banks face rating headwinds due to the weakening of sovereign support under the EU’s Bank Recovery & Resolution Directive.

Issuers domiciled in the troubled eurozone countries of Greece, Ireland, Italy, Portugal and Spain (GIIPS) nations saw their net rating activity leap into positive territory in Q1, outperforming the broader, negative bias, due mainly to a collapse in downgrade volume as upgrades set a five-quarter high.

Total issuance rose 9% in Q114, compared with Q113, buoyed by a 16% boost in new volume from issuers in the eurozone as sovereign ratings and outlooks received a boost and sovereign benchmark yields tumbled to multi-year or record lows. Entities in GIIPS nations ramped up issuance by 33%, led by Italian issuers, which supplied almost 40% of their entire 2013 bond issuance volume.

Financials boosted issuance by 12%, outpacing non-financials by 6 percentage points (pp), as Italian banks doubled their new bond supply from a year earlier. The move contrasts with ongoing deleveraging pressures faced by the sector, and may reflect a release of pent-up supply as markets grow more comfortable with Italian and Spanish bank risk, coupled with positive spill-overs from emerging market (EM) volatility through much of the quarter.

Coupons on new issues dropped below 4% in Q114, and issuers were able to extend maturities and boost the share of lower-rated bonds amid keen investor demand for an additional pick-up in yield. The share of bonds with maturities of 10 years or more rose to 31% – the highest level since 2006 – as the portion of lower-rated bonds also increased.

Refinancing in the year to date is 5pp higher, at 42%, than at the same period last year due to a 7% decline in maturities and marginally higher issuance. Financials issued bonds amounting to one-third of their 2014 bond maturities in the year through April, while non-financials have already refinanced 81% of maturities.

European high-yield (EHY) issuance grew 9% in Q114 and the market remained open amid EM volatility, as yields on bonds from non-financials fell below 4% for the first time. The GIIPS-uplift theme was also evident, facilitating the surge in new bond supply as banks remain cautious on their lending. However, concerns continue to mount over shrinking risk premia in European high yield (EHY) as investors accept ever-declining yields with increasingly issuer-friendly terms.

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