European High Yield Issues Outstrip US
Despite recently volatility, bumper issuance in the European high-yield (EHY) bond market thus far in 2014 has pushed volume ahead of US high-yield (USHY) for the first time as yields marked new lows and the default rate remained below the long-run historical average, reports Fitch Ratings.
Total issuance grew 34% year on year (YoY) in the first half of 2014 to €113bn, with higher junior bond volume from banks – which rose 3.7x during this period – being an important driver.
Persistent below-target inflation in the eurozone and accommodative monetary policy contrasts with the US and UK, where economic recoveries are more advanced and expectations for rate hikes are stronger. The policy divergence may provide key support for EHY for the rest of the year, while rising merger and acquisition (M&A)-driven issuance indicates an important additional driver of new bond supply to complement refinancing as economic conditions continue their gradual recovery.
Assuming operating cash-flows remain stable-to-improving, as many issuer managements expect, the outlook for EHY remains compelling, says Fitch. However, recent volatility shows it is not impervious to shocks and lack of spread premia limit protection against future sell-offs. Nonetheless, many investors confident in the EHY market’s adequate liquidity and long-dated maturity profile of most high-yield issues may welcome a market correction that returns premia to the market and rewards credit-selection.
Consistent, positive monthly performance drew record net inflows to EHY since last October, but the July market sell-off sent total returns to negative territory for the first time in 13 months, signalling a deceleration in inflows. While EHY has outperformed other fixed income asset classes through most of H114, returns in the year through July suffered as recent flight-to-quality pushed European placed investment-grade returns marginally ahead.
Issuance from Greece, Italy, Ireland, Portugal and Spain (GIIPS)-based entities grew further as benchmark yields fell to record lows in Italy and Spain, reflecting investor bias towards troubled economies as they tried to bolster returns under the cover of central bank liquidity. Italian and Spanish issuers took the opportunity to increase H114 issuance by 3.3x year on year to €28bn, amounting to 77% of total HY issuance from GIIPS entities compared with 60% in H113.
Investor sentiment for EHY has shown signs of waning as the risk-reward profile shifted further in favour of issuers through the year. A recent Fitch survey saw European investors relegate EHY to the second most sought-after fixed-income asset class on mounting risk pricing concerns, ending a five-quarter run as top choice.