Fitch: Euro High-Yield's Selective Haven Appeal Fails to Lift Annual Issuance Outlook
The poor start to 2016 resulted in new issue volume being halved yoy in 1H16 to EUR56bn, a period in which yields were on average 1pp higher. We expect full-year 2016 corporate new issue volume in developed markets to be down 30%-40% from 2015's EUR145bn.
Lower growth estimates for the UK and the eurozone following the Brexit referendum have less immediate impact on the outlook for credit quality than the accompanying stimulus of accelerated asset purchase programmes and negative yielding benchmark rates have on secondary market yields. In comparison with US high yield, EHY's stronger mix of 'BB' and strong business model 'B' issuers make it an attractive "buy-the-dip" asset class. Yields on EHY bonds now stand at approximately 30bp wider than their all-time low established in March 2015.
Much of the new issue activity relies on proven legacy issuers opportunistically refinancing high coupon debt from 2012 and 2013, when the loan market was still effectively closed to large volume issuers. The post-crisis "bank-to-bond" phenomenon slowed precipitously with the recovery in bank funding costs and return of collateralised loan obligation issuance in 2014. In addition, towards the end of 2014, increased volatility from a diverging policy rate path in the US, the slowdown in emerging markets and credit deterioration in global commodity sectors resulted in spill-overs to funding market conditions in Europe.
Investors remain sensitive to credit selection after suffering volatile returns in 2015 and early 2016. Poor secondary market liquidity on many single-issue mid-market borrowers and larger issuers with exposure to the emerging market slowdown highlighted a new set of stricter new-issue market conditions that continue to prevail despite the recent rally in the US and Europe.
Investor risk aversion in EHY is evident in the spread gap between 'B' and 'CCC' rated segments, which remains elevated relative to pre-1H14 levels, after widening in unison with the collapse in oil prices and the rising US dollar.
Total returns for EHY lag both sterling high yield (SHY) and USHY; however, on a risk-adjusted basis, EHY outperforms USHY over three and five years; i. e. it has shown superior annualised returns with lower annualised volatility over these periods. This outperformance is driven mostly by the fallen-angel heavy 'BB'-rated category in EHY, which comprises over two-thirds of the market, compared with less than half of the market for USHY.
The trailing-12 month default rate for EHY doubled yoy to 0.89%, by volume, through end - June 2016, and is projected to end the year at between 1% and 1.5% - levels last seen in 2013. The expected pick-up in the default rate reflects the rise in the share of outstanding EHY bonds rated 'B-' or below in 1H16, to 17.5%, similar to 2013 levels.