A market focused on idiosyncratic stories
September was a weak month in European credit markets; renewed concerns around the growth outlook for the region and the future course of the Fed and ECB policies contributed to the current investor fatigue. Cash indexes were down around -1% – a more limited downside than the -2% drop experienced by the US HY market – while the iTraxx Main and Xover indexes widened by 7 and 30bps, respectively.
A number of relatively high-profile credit events grabbed investors’ attention and magnified the poor performance of the lower-rated segment of the HY market and of bank hybrid capital instruments:
More generally, HY indices outperformed most single-name HY instruments – including those of companies with no negative idiosyncratic news. Macro headlines and expectations have been supportive to indices. However, investors have been reluctant to add single name risk in the context of events.
The HY primary market stayed open for the higher-rated names, with a dozen of issuers raising ca. EUR 6 bn of capital. However, it was not as smooth a ride as it had been in the first part of the year. The September new issue by Belgian mining company Nyrstar is a case in point. The bond was initially expected to price in the mid-to-high 6% range after launch. A few days (and credit accidents) later, the price guidance was 2% higher, in the 8.75%-9% range. The new bond finally printed at the upper end of the guidance at 9.00%. It now trades at 95 cts.
To sum up the situation:
The back-of-the-envelope calculation that scares credit markets
News that Bill Gross – founder and CIO of Pimco – decided to quit his employer to launch a new fund at another asset manager caught the eye of the market. Beyond the gossip and curiosity for such an unexpected announcement made by one of the most respected fixed income investors lies a more fundamental reason. Pimco manages approximately $2trn of assets, mostly in fixed income products. As a result, every market participant was quick to make their own assumptions on how much of those assets were at risk of leaving Pimco and what impact it could have on their own market and positions. We are no different although we do not have any particular edge to make estimates of future outflows at Pimco. The interesting thing to us is the translation of percentage points of redemption at Pimco in potential supply of European HY and bank subordinated debt in the secondary market. Based on the firm’s public disclosure of holdings, we estimate that every percentage point of redemption – remember that 1% at Pimco equates to $20bn of positions – could put $1bn to $2bn of European credit assets looking for a bid in the secondary market. The sheer size of such risk combined with the very large positions held by Pimco in certain instruments is raising fear. For example, public disclosure indicates that Pimco owns at least 11% of the €1.25bn Numericable 5.625% 2024 bond in HY and 35% of the $1.52bn Barclays 10.179% 2021 subordinated bond in the hybrid financial space . The bad news is that nobody knows when the market will have a clear view on the quantum at risk. The good news is that certain segments of European credit markets such as bank hybrid capital and lower-rated HY have repriced and became more volatile.