05 Octobre 2014

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:

  • the senior secured bonds of UK-based mobile phone service retailer Phones 4U fell 65 points after the company unexpectedly announced the end of its distribution contract with its two main customer (Vodafone and EE) and went into administration. The PIK notes issued out of the holding company in September 2013 dropped 85 points and are now quoted below 5 cents on the euro;
  • European online travel company eDreams Odigeo’s bonds fell 10-20 points on the back of weaker than expected quarterly earnings – its share price is also down 75% since its April 2014 IPO;
  • German armament manufacturer Heckler & Koch’s bonds traded down 25 points as the company reported a significant drop in sales.

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:

  • in markets driven by excess liquidity and flows, investors want the return of HY without the credit risk. As a result, bonds are not in strong hands and any disappointment can trigger a fire-sale;
  • second-tier companies – i.e. the 150 or so HY issuers not included in the iTraxx Xover index – are particularly exposed to such distrust and turbulent price movements;
  • there are and will be opportunities to go long on unduly punished credit instruments at discounted prices for investors who can form an educated view and build firm convictions on companies (research, cash flow models, etc.);
  • while it may still be early and somewhat dangerous to fight against the tide of investor flows in the asset class - see more on that topic below -, some low-quality credit stories will not escape investors’ vigilance forever. This will provide interesting single name HY short opportunities in the future.


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.


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