Euro-zone gears up for credit ratings
Standard & Poor's has responded to the growing interest in the high yield bonds and emerging European debt by introducing new ratings services. With the introduction of the euro, it reasons, the credit market is set to take centre stage in European capital markets. Many European organisations are looking to the bond markets for the first time as a source of financing, via regular bond issues and various form of securitisation. In addition, global market volatility has highlighted the need to monitor the creditworthiness of counter parties in general.
Ian Mackintosh, managing director of business development in Europe, says: We believe that the euro will be a strong driver for both disintermediation (corporate will increasingly tap the capital markets and diversify their funding sources at the expense of bank debt) and ratings (name recognition will play a lesser role as the base of investors widens both in and out of the Euro-zone).
European high yield issuance should grow and become a stand-alone asset class, as in-vestors move down the credit curve looking for yields."
The attractions of European high yield are based on an expectation that it will be able to deliver comparable risk-adjusted returns to the US high yield market, which has been the best risk adjusted return asset class over the past 12 years. With the level of M&A activity in Europe set to continue at its rapid pace, and with competition intensifying, the credit implications are difficult to predict. As just one example, in order to in-crease shareholder returns, European corporates might now tempted to increase leverage to up their return on equity.
The level of activity in the funds market suggest though, that there is considerable in-terest in this developing market. S&P estimates there are 10 different high yield bond funds being set up in Europe, and specialist shops being set up to cater for the European high yield market.
Lazard Asset Management has added a European High Yield Bond fund to its Dublin Ucits Global Bond Fund. The fixed interest team will invest in Europe's fast developing corporate bond market which currently includes some 40 bonds from 35 issuers. The ensure an appropriate level of diversification, the fund will also have a strategic 10-15% allocation euro-hedged US high yield securities. Chris McGinty, head of fixed income at Murray Johnstone, warns however that "recent stellar returns in the US, have only been achieved in a climate of the longest per-iod of economic growth this century. Before this, 'junk bonds' helped to cause one of the world's biggest financial crises, leading to the US government's bail-out of the savings and loan industry."
McGinty says investors need to be made aware of the different types of high yield fund. He suggests there is a misconception that all corporate bonds are low risk: "As a general rule of thumb, Government bond yields, plus an additional 2% leaves capital reasonably secure. As euro yields are by and large lower than the UK, a yield of above, say 5.5% in the euro area implies some capital risk." MFS's European operation has been bolstered by the relocation to London of a senior fixed income credit analyst, Richard Hawkins, from the group's Boston HQ. Hawkins comments on the move: "The MFS fixed income team were pioneers in actively trading corporate bonds in the US markets, both high grade and sub-investment grade bonds," (see page 35).
Emerging Europe may be coming back into vogue, but investors are going to be much more demanding, says S&P's George Dallas: "We believe the current ratings reflect the weakness, although statistics might suggest a higher rating.
"If the private sector doesn't contribute to improving the picture for these convergence countries, this will adversely affect their sovereign rating."
The group has defended its rating of Russia, claiming it was not caught out by the market's collapse: "Russia already had a low rating," says Dallas, "and S&P assigned it the lowest rating of all. The issues that were highlighted by the crisis were the ones we had warned about. In 1997, we produced a negative addition to the rating at the time when everyone was still bullish." Dallas suggests Russia's aim of raising money from the IMF and elsewhere is not realistic at this stage: "We see a widening of the debt burden this year."
There has been $1.5bn(£) of issuance in the high yield bond market, predominantly in the telecoms sector, since the Russian crisis: "The foreign players and proprietary trading desks have disappeared," says Dallas. "But we have seen renewed interest from some institutions who have taken the opportunity to assess the issues in more detail. Total issuance in the high yield market is approximately $20bn, which compares with the $5bn total outstanding in 1997. There are around 130 debt instruments from 80 different issuers.
According to S&P, ratings in Europe are quite high, with 30-60% of European ratings at investment quality."