Out of the shadow
For years the European high-yield bond market has been in the shadow of the larger and more mature US business. Yet even in the face of a sovereign crisis, Europe is growing faster.
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The European high-yield debt market is still only a fraction of the size of its US counterpart, but it is evolving into an independent, standalone asset class that plays to the increasing need for diversity in European corporate finance.
“If you’re looking at figures post the last financial crisis, the European high-yield market has actually had a faster growth rate than the US market,” said Michael Moravec, head of European high-yield syndicate and co-head of leveraged finance origination at Barclays in London. “Historically, the European high-yield market hasn’t grown as quickly as some might have wanted, largely because bank lending has always been much more important in Europe. But today, high yield is playing a bigger role and we expect that more and more corporate issuers, even some that have never used the high-yield bond market before, will be looking to make use of it.”
The evolution of the European high-yield market since its inception in the late 1990s to where it stands today has happened in several stages.
“Yes, at the outset we imported technology from the US to build up the market and we relied a great deal on US investors, who saw good opportunity in European high-yield debt after the downfall of the market in 2001-02,” said Tanneguy de Carne, head of high-yield at Societe Generale in London.
But as early as 2004, the market began to acquire an identity that was purely European, he added, thanks to increased European investor interest in high-yield debt and the creation of new European funds devoted to the asset class. More importantly, high-yield bond documentation took on a true European flavour by doing away with the cumbersome SEC registration process that US investors had insisted on, he said. Also the debate over bondholder rights built momentum, finally culminating with bondholders now having equal voting rights as bank lenders.
Of course the financial crisis also greatly enhanced both the role and the appeal of high-yield debt in Europe.
“In 2008 and 2009, mezzanine – which had always been extremely popular in Europe – got completely wiped out, and as the collateralised loan obligation bid for bank loans also went down in Europe, everyone starting looking toward high yield for liquidity,” de Carne said. “Senior bank debt also welcomed high yield to the table, honouring bondholders’ requests for the pari passu status, saying ‘if we don’t get let them come in, we’re not going to get anything done.’”
In the past couple of years, more and more companies have been issuing high-yield bonds, and today, it has become a market that none can afford to ignore. Generally speaking, only 30% to 35% of European companies currently access the capital markets for their funding needs (compared to 70% to 75% in the US), and of these probably less than 5% of European high yield corporates have accessed the European high yield bond market, de Carne said, so the growth potential is huge.
“Because of the pace of regulation in Europe and the capital constraints that banks are facing, we’re going to see acceleration in the change from corporates relying on banks to a much more balanced funding between banks and the capital markets, so this is really a big chance for high yield,” he said.
“Now that we have passed the debate on equal voting rights, now that we have greater transparency and standardisation in high yield documentation, the next step is to see how deep high yield is going to go into the mid-cap corporate market to build up the future flow of new issuance.”
Traditionally in Europe, banks have strictly catered to the mid-market corporate arena. But there is little doubt that the regulatory pressure of Basel III, the higher lending costs – as well as the post financial crisis capital crunch that banks are still dealing with – has already started to change things, Moravec says. In Europe, high-yield bonds have mainly been used to finance leveraged buyouts, he says, but in the past couple of years more and more corporates have been issuing debt for their funding purposes.
The forward pipeline for more corporate high yield issuance looks good, Moravec adds, but there’s one major caveat to its success: Europe’s macroeconomic malaise.
“There’s no doubt that the last few months have been tough for the high-yield market and issuance has been slow,” Moravec says. “Granted, the summer is always slower in Europe than it is in the US, but the sovereign situation continues to dog the market and investors are definitely cautious, particularly over credits from the non-core European countries. This will certainly impact issuance going forward.”
The European Central Bank’s recently unveiled bond buying programme gave some reprieve to the markets, enabling a few high-yield issuers from peripheral nations to come to the fore. In September, Buzzi Unichem, an Italian cement company, and Brisa, a Portuguese toll roads concern, both came to market. But overall, it’s the high-quality names like Wendel, Renault, Smurfit Kappa and UPC that have dominated, says Chris Brils, co-head of global high yield at F&C Asset Management in London.
“There has been huge demand for higher-quality paper in Europe, even though some accounts have been buying peripheral names in the secondary market,” Brils said.
Many high-yield companies have managed to refinance their obligations through 2015, which means they don’t have to come to the market for a while.
This year, too, many European corporates have been able to dodge any difficulties in the euro market by issuing high-yield debt in US dollars, thereby cashing in on the continued appetite of US investors for European high yield.
But the need for improved returns means Europeans may not have to turn to the US again as investors in Europe are going to increasingly choose high yield going forward, says Curt Lyman, senior managing director at HighTower Advisors in Palm Beach Gardens, Florida, who follows the European high yield market for US clients.
“There’s a structural shift going on in Europe, where investors are looking at banks with a more jaundiced eye and tending to favour putting their money in bond funds,” Lyman said. “Now, with greater protection for European high-yield bondholders, a lot more people would rather put their money there than in a bank or a government bond.”
Brils agrees as the coupon clip remains attractive, high-yield bonds are less interest rate sensitive and many issuers are still able to improve their balance sheets.
“There’s really hardly anything else to invest in within fixed income, since core government bonds are not attractive going forward and investment-grade yields are so low,” he said. “High yield has become the asset class, by default, still attractive from an income perspective.”