The performance of the European high-yield market has been remarkable. Sustained economic growth wor...
The performance of the European high-yield market has been remarkable. Sustained economic growth worldwide, good liquidity in the high yield market and increasing demand for this asset class in Europe are some of the drivers of the strong performance.
Compared to the US, Europe also benefited for a long time from lower default rates and growing expectations of a slowdown in the US economy, while growth in Europe showed continued strength. This even allowed European high yield to outperform its US counterpart in 2004 and 2005.
Default rates in the global high-yield markets have hit historic lows. According to Moody's only 1.75% of companies in the global high-yield market went bankrupt in the course of 2006. This is the lowest year end figure since 1996 and thus markedly below the long-term average of 4.5%.
The low default rates in Europe are the result of the good economic environment on the one hand and high demand for high-yield bonds on the other. The still low interest rates and a certain willingness by creditors to take risk, currently allows even financially weaker companies relatively easy access to credit.
Demand for high-yield issues is unlikely to subside in 2007. Thus it is easy for companies to extend existing debt without liquidity problems and payment difficulties arising.
However, Europe's high-yield market is something of a two class society. Over the past year we have seen new names in the market with markedly higher debt. Many of these issues came in the wake of a leveraged buyout.
Takeovers are a driving force behind the volume of issuance in the high yield market with about 65% of new high yield bonds in Europe currently a result of leveraged buy-out financings. However, in the difficult years of 2001-2002 many weak companies went bankrupt and disappeared.
The survivors from that period are today's so-called seasoned issuers. These have mostly had very good profit growth, which has contributed to the narrowing of spreads and made the high-yield sector quite healthy overall.
How long this continues depends on the pace of economic growth, and in Europe, mainly on the impact the economic slowdown in the US will have.
The positive environment for high-yield in Europe should last for some time. But investors will look closely if companies are tempted to take on more risks.