Is credit about to crack in Europe?
I’ve been spending time recently speaking to Man Group’s extensive (and growing!) network of credit experts. It’s always a pleasure to catch up with my friend and colleague Danilo Rippa, Head of Global Credit Multi-Strategy. Danilo has been trading the asset class for decades and is always full of fascinating insights and opinions.
This week, he collared me to discuss a favorite topic of mine – the great regime change and its complex and occluded repercussions. It’s striking to me that the significant volatility in sub-investment grade credit in Europe has gone almost unnoticed by the rest of the investing world. As the chart below, from Goldman Sachs
GS
, shows, the EUR CCC Index – the lower end of the High Yield market – fell almost 8% last week, erasing pretty much all of its year-to-date gains. At a time when there seems to be a pervasive Panglossianism – the best of all possible worlds, the softest of all possible landings – this feels like a useful counter-narrative, evidence of flaws appearing in the system.
Much of the underperformance was driven by a handful of distressed companies who have been drawing increasing investor scrutiny. These companies include global packaging company Ardagh Group, French telecom giant Altice and Swedish debt collector Intrum. The interesting thing about all three of these credits is that the dramatic fall in the value of their bonds was not driven by any major operational issues at any of the companies. Rather, they are merely the most visible examples of a deeper and more systemic issue: the fact that most corporations’ balance sheets were engineered in and designed for an environment of persistently low rates. We are in a deeply indebted world – $305 trillion of debt – and have gone from 0-5% interest rates, now hovering around 4%, in a relative blink of an eye.
It feels like we are witnessing the first ripples of a coming wave of issues for heavily indebted borrowers whose interest payments looked manageable in a zero-rate environment but where the sharp rise in those payments has suddenly pushed them into a position of extreme precariousness.
Strip out these few distressed companies and the performance of High Yield credit looks as rose-tinted as the booming equity markets. As this research from Barclays shows, spreads for non-distressed issuers are now beneath 300bps.
And a third of the High Yield universe is now below 200bps. This is a broader market priced for near perfection.
The question we need to ask is whether the blow-out in a handful of distressed credits is a short-term blip, a kind of SVB for the European High Yield market, or whether it is indicative of a more problematic systemic issue, one that will come into sharper focus if, as many suggest, persistent inflation means that rates stay higher for longer.
