Prising ourselves away from the Lehman, Fannie, Freddie-related hoohah in the US and heading back across the Atlantic, we’re looking at warnings of a looming wave of defaults in Europe’s high-yield bond market.
As Bloomberg reports on Thursday, high-risk, high-yield debt is looking very shakey indeed, with more than 30 per cent of European junk bonds now trading at distressed levels – the biggest proportion in five years
After an eerily quiet period since mid-2007, when Europe’s high-yield debt market was effectively shut, the market is now focused on a wave of debt issuance from corporate refinancing, which is expected to push spreads even wider, as the FT notes.
Investors are now demanding an extra yield over government debt of more than 10 percentage points to hold 53 of the 169 bonds in Merrill Lynch’s Euro High Yield Constrained Index, Bloomberg reports.
Moody’s, in a Sept 8 report, estimates European speculative-grade corporate bonds will climb to 2.3 per cent in a year, from 0.7 per cent now, near a record low. Worldwide defaults meanwhile will surge to 7.4 per cent in a year, from the current 2.7 per cent, adds Bloomberg. But analysts say that if things keep going the way they are, on both sides of the Atlantic, the figure – both for Europe and the rest of the world – could be much higher,
Moody’s warned in late July that the credit quality of Western European corporate borrowers had deteriorated to a level not seen since 2003, and could worsen as European economies grapple with rising inflation and slowing growth, exacerbated by the credit crunch.
As Kenneth Emery, Moody’s director of corporate default research, pointed out last month, the lack of issuers with debt coming due this year, and the prevalence of covenant-lite deals, have helped keep a lid on defaults. But, “as we move through this year and 2009 that lid will be removed…The storm is gathering for default rates moving up”.
Bloomberg notes that companies last year borrowed the equivalent of $32.1bn in Europe using such securities, with all but $5bn of it transacted in the first half. Now, amid escalating money-market rates, investors are wary of speculative borrowers.
Among those that sold bonds when the high-yield market was active in the first half of 2007, Whistlejacket, the structured investment vehicle associated with Standard Chartered, defaulted on £45m of senior notes sold in June 2007. Norske Skogindustrier, the second-biggest newsprint maker, are at a spread of 1,016bp more than government debt, according to RBS while those of car rental company Europcar Group are at 1,441bp.
Already, spreads on high-yield debt have widened as investors, fleeing the US turmoil, shun all but the safest bonds and as banks tighten lending standards. The average yield in the Merrill High Yield index, an indication of the absolute cost of debt to companies, is now 12.3 per cent, twice the level of last March, adds Bloomberg.
In its most recent report, Moody’s warns that makers of durable consumer goods such as furniture and fridges are likely to show the highest default rate in Europe. According to Bloomberg, the companies with the largest share of bonds in euros at distressed levels are General Motors and its finance unit, General Motors Acceptance Corp.
And to end, for now, on a really cheery note, Karl Bergqwist, who manages high-yield debt at Gartmore Investment Management in London, tells Bloomberg: “We think there’s much worse to come. Spreads could go a lot wider and defaults are undoubtedly going to go up”.