| Heady days coming to an end for high yield |
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| 26/12/2006 | |
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Speculative-grade credits saw more upgrades than downgrades in 2006, offering investors double digit returns. But those heady days are about to come to an end. High yield spreads could widen 50 basis points in 2007 at the first sign of a corporate failing or mini-fund blow up. The market is awash in liquidity at the moment. Indeed, at €23.2 billion, the volume of European high-yield issuance has surpassed full year issuance from all prior years. Meanwhile, European high yield returns are hovering around 10.2% year-to-date, according to data from Merrill Lynch. Strong demand has shrunk spreads on the five-year Merrill Lynch Composite High Yield Index to 252 basis points from nearly 400 basis points at the end of 2005. Standard & Poor's expects spreads to widen 50 basis points "should we have a blow up on the radar screen," says Diane Vazza, a credit analyst at S&P. "The rally is clearly not sustainable and the market is being propped up with unprecedented levels of liquidity." Junk spreads its wings Specifically, the rating mix in speculative grade credit has tilted toward lower-rated issuers, with the share of B-rated issuers to speculative grade hitting an 11-year high (BB+ rated credit is the highest in the speculative segment). Nearly half of issuers are in the junk segment, the highest in history, compared to 41% in 2005 and 36% in 2004. "The search for yield continues to support the low credit quality in Europe and the same trend can be observed in the U.S. high yield market," says Vazza. The media sector is particularly vulnerable. S&P cites the EMI Group in the UK (BB), which it has placed on negative credit watch. Others include, Editis Holdings (BB/Stable) in France and Codere (BB/Stable) in Spain. Geographically, Germany remains particularly exposed. S&P has placed Allgemeine Hypothekenbank Rheinboden AG (bank/BB-), Fresenius AG (health care/BB-) and TUI AG (transportation/BB-) on negative credit watch. LBO activity has been the driving force behind the growth in European high yield activity in recent years. In the European bond market, close to half of new speculative grade issues in 2005 and 2006 were related to LBO and merger activity. LBO loan volume surged from €14.3 billion in 2003 to €78.2 billion in 2005, while non-LBO loan volume shrunk from €30.8bn to €15bn during the same period, notes S&P. The European Central Bank (ECB) concurs. "The rapid growth in the value of LBO transactions has taken European leveraged issuance beyond levels last seen at the height of the telecom boom of the late 1990s. At the same time, the average degree of leverage in these loans measured by debt-to-EBITDA ratios has increased substantially. As a result, the credit quality of issuing companies has deteriorated." V.B. |
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