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March 11, 2013

European High Yield Will Do Well by Issuers and Investors

Although the European high-yield bond market benefitted from significant investor interest through last year and got off to a great start in 2013, it did not escape the general downturn that affected all markets following Italy’s election deadlock last week.

Fears that the European crisis would once again raise its head caused spreads on almost all high-yield bonds to widen last week, in particular bonds from peripheral European countries such as the Spanish telecom company ONO and Italy’s Wind Telecommunications, according to Chris Brils, director and co-head of global high yield at F&C Asset Management in London.

“Once again at a time of uncertainty, credits that have pure domestic exposure to European peripheral countries are selling off and those from core Europe are being perceived as a safe haven, which shows that the European high-yield market is still very sensitive to peripheral news headlines and fearful of the European sovereign crisis overhang,” Brils said. “[But] a week from now, things could be different, and the search for yield could continue, as high-yield is really the default asset class, since it’s one of few places within the fixed income universe where you can earn some yield.”

Sure enough, it is that rationale that attracted money into high yield through 2012 and continues to bring money into high yield bond funds this year. While some are predicting marginal increases on German Bunds by the end of the year, real yields for perceived safe-haven governments continue to be negative, said Christian Weber, senior strategist, credit strategy and structured credit at Germany’s UniCredit, adding and for investment grade corporate bonds, the real yield is around zero.

“High yield will continue to attract investors, even if in absolute terms, the yields on high-yield bonds have reached historic lows. However, this has happened on the back of declining government yields while in terms of credit spread, the valuation of high yield bonds still looks fair given strong credit fundamentals, low default rates and a gradually improving economic outlook,” Weber said. And despite the temporary malaise following the Italian election news, prospects for the European high yield bond market, even if it’s a stop-and-go market, look good this year, both for investors as well as issuers, he said.

“Year-to-date, we have had close to E16 billion in high yield bond issuance from European companies, and whereas last year double-B credits made up more than half the market, this year so far we have seen a lot more single-B and triple-C issuers, which means that the appetite for risk is high and the chase for yield is very much on,” said Tanneguy de Carne, global head of high yield capital markets at Societe Generale in London. “From the investor side spreads are tighter in Europe and this is raising a few questions and concerns that this year, after the massive rally we have had last year, that investors will struggle to generate the same returns. But most professionals expect European high yield to generate returns of 6% to 8% this year.”

Indeed, European high yield generated a total return performance of 27.2% in 2012, the best for the year, according to Bank of America Merrill Lynch index data. U.S. high yield, meanwhile, only returned 15.6%.

At the start of 2012, investors in European high yield debt were assured a 165 basis point spread differential over U.S. high yield bonds and that incremental return has completely disappeared as a result of the massive rally in credit spreads earlier throughout 2012.  European high yield indices now trade around 25 basis points in spread over comparable U.S. high yield bond indices.

The increased appetite for risk from European high yield investors has also allowed companies such as ENCE, a Spanish manufacturer of pulp and paper products, Italian white good manufacturer Zobele and French servicing company Atalian—all mid-cap companies—to successfully sell high yield debt this year. Some have done so for the very first time ever, said de Carne, and at pretty competitive pricing.

“One of the themes of the European high yield bond market this year is going to be inaugural deals from mid-cap issuers,” he said.

De Carne said he is also expecting primary leveraged buyout (LBO) and M&A financings to pick up in 2013, a move that would mark a change from the past couple of years, where companies used high yield bonds to opportunistically refinance bank debt. The M&A financing for the acquisition of Virgin Media by Liberty Global was a huge deal and very well received, and there are other examples such as Cerved, a tax software manufacturer, which financed E780 million in for a CVC-lead LBO via three bond tranches, de Carne said. “This is the kind of deal we’ve been longing for in Europe for some time.”

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