And the high-yield boom continues…

Posted by Tracy Alloway on Jun 22 11:28. 1 comment | Share

It’s the clash of the high-yield press releases this Wednesday.Here’s Standard & Poor’s, with a new high-yield report published at 9.55am London time:
Record demand for high-yield bonds in Europe carries downside credit risk
And here’s Baring Asset Management with a press release of their own sent out 20 minutes later: More…

It’s the clash of the high-yield press releases this Wednesday.

Here’s Standard & Poor’s, with a new high-yield report published at 9.55am London time:

Record demand for high-yield bonds in Europe carries downside credit risk

And here’s Baring Asset Management with a press release of their own sent out 20 minutes later:

High-yield debt market will continue to offer most attractive fixed income opportunities, Barings says

Some confusion there.

High-yield debt, a.k.a. junk, has been the darling of the investment world in both Europe and the US in recent months, as a way of picking up yield in a low interest rate world. European high-yield issuance reached €14.5bn in the first quarter of this year, and 2011 looks on course to top 2010′s €44bn. Which, incidentally, would also far surpass the €24.3bn issued in 2007, at the height of the credit boom.

Barings says the asset class is attractive “on an absolute basis and also relative to other fixed income asset classes,” with still “solid” fundamentals. They’re also saying the bonds are less correlated with interest rate volatility , which might come in handy if central banks ever decide to raise rates.

What’s really amazing though is that demand — like from Barings — is still outstripping supply.

From the S&P report:

However, despite the surge in issuance, demand for high-yield bonds is still outstripping supply. As a consequence, yields are falling as the current low interest rate environment causes investors to pursue yield by pumping cash into high-yield bond funds in Europe. This is extending the way that high-yield bond issuance is being used, thereby creating an environment where companies (particularly lower-rated credits and those under private equity ownership) can more easily access capital. Although this improves companies’ liquidity, we believe it also introduces a potential downside risk for credit quality. For example, as Standard & Poor’s Ratings Services observes, it’s already leading to lower average recovery ratings on senior secured debt.

In other words, all this high-yield issuance has also meant companies tweaking their capital structures, with senior secured bonds now sitting below things like super-senior revolving credit facilities.

Meanwhile, European junk has also been getting, well, junkier. As of May 2011 about 70 per cent of companies tapping the high-yield bond market in Europe were in the ‘B’ rating category (in the non-investment grade/speculative bracket), S&P says, compared with just over half back in 2009.

Anyway, the S&P report ends with this little warning:

Nevertheless, while we observe that the high-yield bond market is becoming more ingrained in Europe, we would also caution that buoyant credit markets can bring a potential downside for credit quality. In any period of positive market sentiment, higher risk tolerance from investors often goes hand in hand with more aggressive financial policies from companies, as we’re starting to see in the U.S. Although we’ve seen this happening to only a limited extent in Europe to date (four dividend recaps in 2010, four in 2011, and a handful of PIK note issues), it’s something that we monitor because it can signal an increase in credit risk.

Do you think Barings cares?

Related links:
Demand for high-yield assets boosts risky second lien loans – FT
Investors really ♥ junk. We mean really. – FT Alphaville
Pricing risk, redux – FT Alphaville

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