On the assumption that what America does today, Europe copies tomorrow, Gartmore’s head of credit research, Richard Fletcher, sees the European corporate fixed income market emulating the US, including the high yield, sub-investment grade sector. He says the techniques for analysing credit risk used in Europe and the UK are becoming more sophisticated: “I expect the corporate investment grade market to grow steadily over the next few years, increasing liquidity in the high yield sector. At the moment European corporate bond markets and the sub-investment grade sector are underdeveloped in scale and efficiency compared with the US market. The high yielding sectors have been dubbed high risk but defaults on corporate bonds are measurable in a portfolio context. These tend to worsen in recessions or economic downturns, whereas credit conditions in European economies today are relatively benign”.
The corporate market is exhibiting strong correlation with European sovereign bonds but not to the extent that their US counterparts do with US Treasuries. Although European government bonds show some correlation to domestic equity markets, there is practically zero correlation between European corporate bonds and equities. Jeremy Yates Edwards, manager of the new Baring euro bond fund, says one of the key reason for the development of the corporate market is more competition in the increasingly open European market, with less government intervention: “Companies are willing to adjust their debt/equity mix, increasing gearing to enable them to give equity holders a better deal. In practice, companies going down this route may suffer a deterioration in credit rating. However, the costs of remaining or becoming an AAA-rated name as opposed to an AA-rated far outweigh the benefits and many European companies may follow the path of strategically lowering credit ratings to reward equity holders. This is noticeable in the US, where the corporate bond market is much more developed”.
Organisations not domiciled in the Euro-zone may also raise debt in euros, primarily to diversify their investor base. US corporates for example, may want to reach new investors and raise their profile in Europe. There are currently 1,570 investment grade corporate issues in Europe, compared with 3,550 in the US. The speed at which the European market is growing is demonstrated by the fact that there was $112bn of issuance in Europe for the six months to June 1999, compared with only $30bn in the equivalent period two years ago.
Joseph Biernat, head of credit research at Paribas confirms the upward trend remains, with demand for euro paper continuing to be strong. And significantly, total deal size has increased since the introduction of the euro, and is particularly strong in the corporate sector. According to analysis by Paribas, average deal size in the corporate sector is E416m, compared with E242m in the financed sector and E307m in the sovereign/supra sector. Biernat says: “This is considerable when you realise that the corporate figures do not include either the landmark E3bn Mannesmann deal or the E3.25bn Repsol issue, which were announced after these figures were compiled”. Richard Newell