Europe’s High-Yield Market Is Pricing Out Lower Rated Companies

(Bloomberg) -- The new issuance market for speculative-grade bonds in Europe may have become too expensive for all but the better rated and most liquid borrowers after a bout of volatility late last year.

Companies rated single B or lower have almost disappeared from the primary market as a more sensitive buyer base demands premiums from even those issuers with better ratings. Bond sales in the region have dropped to half of what was seen at this time last year, with only 350 million euros ($399 million) of the 4.7 billion euros sold in 2019 coming from issuers rated lower than double B, according to data compiled by Bloomberg.

“From what we see of the European pipeline, we don’t expect there to be a stampede of high-yield buyers any time soon,” said Ben Thompson, JPMorgan Chase & Co.’s London-based managing director for high-yield and leveraged finance in EMEA. He added that borrowers are less confident about new issue price levels and launching non-critical financings, a result of a “modest hangover” in credit from last year.

The slow issuance activity has seen some investors turn to the secondary market to source assets, helping spur a 133 basis point rally in high-yield spreads since early January. But that tightening hasn’t gone far enough for those companies at the bottom of the rating scale or with a troubled credit story. Bankers say that such borrowers will need to wait for a sustained pickup in supply volumes before they can consider refinancing their debt.

Demand Side

It’s not only the secondary market that is helping to alleviate the pressure on portfolio managers to stay invested amid a dearth of fresh supply in Europe. New issuance in other regions such as the U.S. is another option for those with global mandates while modest fund outflows in recent weeks mean there’s less need to buy additional bonds.

“We’re diversified across the U.S. and Asia so we’re certainly never forced into the European primary market, we’ll continue to be selective,” said Uli Gerhard, a senior portfolio manager at Insight Investment Management Ltd., which manages $791 billion of assets.

James Turner, head of European leveraged finance at BlackRock International Ltd., said the current period of inactivity is just part of “the natural ebb and flow” of the bond and loan markets, with the latter looking more appealing to borrowers now given strong CLO demand for the product. But conditions can change.

“For the dynamic to swing back in favour of the high-yield market, we’d need to see the CLO market shut down, perhaps if spreads on AAAs increased to levels that forced loan pricing wider again,” Turner said. “In addition, the ongoing strong performance of the high-yield market could help bring about a pricing re-balance between the two markets.”

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