Mars 2015 - Crédit - US Invasion

Over the past few months, we commented extensively on the expected impact of the ECB’s QE program on European fixed income markets. We estimate that the program will generate at least €400bn of excess liquidity annually to be reallocated into non-eligible assets, such as corporate and financial bonds, among others. That’s for the demand side of the equation. For the supply side of the equation, it’s interesting to focus on some new issuance patterns which are currently developing in Europe.

Debt funding for European IG corporates and financials has been largely dis-intermediated for more than a decade. That being said, euro-denominated IG net issuance has been negative for the past 5 years as banks reduced the size of their balance sheets and reduced their reliance on the wholesale market for funding, while corporates maintained conservative leverage and financial policies. In total, more than €500bn of capital invested in euro-denominated IG bonds has been redeemed to investors since 2010, thereby accelerating the trend of tighter spreads and lower yields in that market segment.

We believe that such trend may start to reverse with two main forces driving the change. First, we expect that a significant number of European IG corporate borrowers will start to releverage as the region’s economic environment stabilizes and borrowing costs have reached historical lows. Second and most immediately, an increasing number of non-European borrowers have started to tap the euro-denominated bond markets for their funding needs and pick up the slack generated by five consecutive years of net redemption in European IG portfolios. Specifically in the euro-denominated IG corporate primary market, issuance volumes in Q1 2015 already amount to 42% of 2014 volumes. US-based borrowers are the largest contingent of issuers in that market with more than 26% of total issuance so far this year, i.e. 77% of the total volume they issued in 2014. 3 high-profile transactions exemplified such a powerful trend; AT&T issued ca. €2.7bn of 9 and 20-year bonds, Coca-Cola issued more than €9bn of bonds with tenors ranging between 2 and 20 years and coupons between 0.186% and 1.625%, and Berkshire Hathaway issued ca. €3.2bn of 8-to-20-year bonds in the same price context.

We witnessed a similar pattern in euro-denominated IG financial issuance where the largest US banks – e.g. Bank of America, Citi, J.P. Morgan, etc. – stepped up the use of that market for their funding needs. US banks already accounted for 15-20% of senior unsecured issuance in 2014 and have maintained a sustained pace of issuance in Q1 2015.

One market where such trend was lagging was the euro-denominated HY market – only 2.4% of the 2014 bond volumes were issued by US-based borrowers. But there again, things are moving in the same direction despite 5 consecutive years of record issuance by European HY borrowers. In Q1 2015, US issuers – such as IMS Health, Valeant and Huntsman, among others – accounted for close to 10% of the total euro-denominated issuance volumes, up more than 125% vs. 2014.

Last, we expect that the bank hybrid capital market will also experience a similar pattern as growth continues. In Q1 2015, more than €15bn of AT1 bonds were issued by European banks vs. €45bn issued in 2014, putting us on track for €250-300bn of outstanding volumes in a few years. In that context, we believe that US banks will also likely tap the European bond market to raise subordinated capital going forward.

Overall, those developments highlight the outstanding momentum currently enjoyed by European credit markets. With a unique combination of robust fundamentals – we expect default rates to stay at historical lows in the next 18 months – and unprecedented technical forces, we continue to find a growing number of exciting opportunities to deploy capital in European credit for the next few quarters.