Wednesday, 12 December 2018

Braced for a blistering pace

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The European high-yield market smashed all records last year, and with a little luck it should keep up the pace in 2014.

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In 2013 the European high-yield market not only broke previous supply records – it obliterated them. Total euro high-yield corporate issuance was €68.7bn, according to Societe Generale, more than 60% higher than the previous record of €42.9bn in 2010.

It was not just in euros either. Sterling saw a spate of issuance as well, with deals such as Virgin Media and The AA redefining what can be achieved in what used to be a niche currency. More than £12bn of high-yield bonds printed in sterling last year, compared to a 10-year annual average of just £1.5bn before this.

Can the market maintain that blistering pace this year? Disintermediation pushed many European corporates into the embrace of high-yield in 2013, while yield-starved investors happily bought up everything from Greek margin debt to deeply subordinated PIK notes.

Europe’s banks are on the mend, however, and if they muscle back into corporate lending, fickle companies will probably go where the debt is cheapest. The spectre of a rates rise also threatens to derail the bond market, and the hunt for yield should lessen as central banks pull back support.

Yet despite these potential headwinds, market participants remain upbeat.

“In terms of issuance, I think we should have a similar year to last year,” said one high-yield syndicate banker. “There’s a reasonably large maturity wall coming up that many will want to address this year, coupled with a very accommodating high-yield market where anyone and everyone are considering if they can issue. If you can get longer-term non-amortising capital at attractive rates, why wouldn’t you do it?”

Analysts agree that the trends that underpinned the market last year are not going away in 2014, and generally predict that issuance will be along the same lines.

Societe Generale credit strategist Suki Mann is predicting €60bn of issuance, while JP Morgan analyst Daniel Lamy pegs the figure at €75bn. Lamy does, however, think that the wave of bond redemptions will mean a drop in net issuance in 2014.

Tighter and tighter

While issuance has started slowly this year, market conditions are incredibly accommodative. The iTraxx Crossover, a synthetic index often used as a barometer of sentiment in the European high-yield market, is now back at pre-crisis levels. The index is hovering around the 280bp mark, levels not seen since mid-2007, and Barclays analysts predict that the index could end the year bid as tight as 245bp.

This is particularly astounding as the Crossover was bid as high as 537bp in the midst of June’s taper tantrums, which triggered a sell-off across high-yield credit.

Inflows also continue to underpin the market. Nearly €340m flowed into European high-yield funds in the week ended January 8, according to JP Morgan. This is the highest inflow since October and means high-yield funds have now seen 18 consecutive weeks of inflows.

If these accommodative conditions are joined by a pick-up in M&A activity, then high-yield could get an even bigger boost. High-yield bonds are often a key component of leveraged buy-outs, while IPOs or sales of high-yield issuers crystallise an equity cushion for bondholders.

Rising equity multiples should close the valuation gap between buyers and sellers that has hitherto stalled M&A activity, although some in the market do caution that this could have unintended consequences.

“While rising equity valuations should be a good thing for M&A, it can sometimes make sponsors more inclined to wait and see if they can get a better price further down the line,” said a high-yield banker.

While the sell-side remains upbeat, the corollary for the buyside is that returns are likely to suffer further. From double-digit returns in 2012, the high-yield market slipped to high single-digit returns in 2013.

“Return prospects are set to worsen yet further,” said JP Morgan’s Lamy. “Yields are currently at record lows of 4.75% and cannot realistically compress much further.”

JP Morgan predicts returns of just 3.4% in 2014, around half what was on offer in 2013. While returns may be dwindling, though, Lamy notes that Europe at least looks set to outperform the US once again.

Robert Smith



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