The highest premiums in seven years are being paid by Europe’s most risky corporate borrowers to access the €412bn junk bonds market. This is a sign of growing concerns that an extended period of high rates and a slowdown in the economy could lead to further defaults.
According to an ICE BofA Index, the “spread”, or gap, between yields of euro-denominated debt rated triple C and lower and government papers has widened by more than 18 percentage point on average.
This is the largest spread since June 2016, and it surpasses the levels in 2020, when the Covid-19 Crisis sparked fears of bankruptcies and messy defaults. The spread was as low at 6.7 percentage points in the beginning of last year.
In recent weeks, government bond yields on both sides have skyrocketed. This is due to fears that the Federal Reserve as well as the European Central Bank would keep interest rates “higher longer” in order to control inflation. Corporate bond yields are rising at an even greater pace.
Spreads that are increasing indicate bondholders want to be compensated for default risk by paying higher premiums.
According to Moody’s, among the European companies that have defaulted in recent months on bonds or loan are French retailer Casino Guichard Perrachon, Netherlands manufacturer Keter, and Belgian Ideal.
Investors and analysts said that the increase in risky European spreads reflected persistent concerns about the health of Europe’s economy. The structural problems in Europe’s high yield bond market, including its lack in depth and liquidity, have also fueled sharper movements than in the US.
Christian Hantel is a portfolio manager for corporate bonds at Swiss firm Vontobel. He said, “I believe the economic backdrop in Europe has deteriorated more than the US.” The spread widening “must be seen within the context of the slower economic growth, aggressive interest rate increases and the continuing elevated inflation numbers”. Many more North American companies have defaulted on their debt so far this year compared with Europe. Spreads for triple-C rated bonds in the US have also yawned wider since the end of the summer, as markets have increasingly priced in expectations of interest rates staying elevated well into next year. But they remain tighter than their European counterparts at roughly 10 percentage points, around levels seen just a few months ago.
Analysts say that very low-grade European borrowers are also affected by a smaller investor base than those in the US where the market for high-yield bonds is worth $1.3tn ($1.1tn ).
“Europe has a financial system based on banks.” Torsten Slok is the chief economist of Apollo. He said that America has a financial system based on markets. There are fewer options in Europe. You can only go to the banks, since credit markets play a smaller role.
The relatively small size of the market also allows individual credits to exert a disproportionate amount of influence on an index or subindex.
The bond, issued by Altice, a heavily indebted French telecommunications group, with a yield of 29 percent and maturing May 2027, is the one that has the highest weighting, at 4,7 per cent, in Europe’s Triple-C High-Yield Gauge. Bloomberg data show that its spread has increased to over 28 percentage points, up from less than 26 percent in late September.
The spreads on European credit cards were likely affected by the risk aversion associated with the Israel-Hamas conflict this month.
Hantel, of Vontobel, says that times of economic and market uncertainty usually affect the lowest-graded companies most.
He said that Triple-Cs were the weakest link in the universe of high-yield and corporate credit markets. It’s no surprise to see that there is more stress in this area.