Over the weekend, we laid out the latest analysis by BofA’s Barnaby Martin who showed that whereas US junk bonds remained at near record tight spreads despite mounting volatility across most other asset classes, the European junk bond bubble appears to have finally burst.
Specifically, and in stark contrast to shrinking US spreads, European high-yield spreads have blown out by 70bp, with total returns just +13bp, a far cry from the average annual returns of +11% observed over the last decade. Putting this unexpected reversal in context, at the start of the year Euro HY spreads were 80bp tighter than US spreads. Now they are 35bp wider, in large part due to the deterioration in the Italian backdrop, concerns about the end of the ECB’s QE and the recent deterioration in the European economy.
While we noted several key conclusions one could draw from this inflection point, one notable observation is that it was just a matter of time before the HY weakness spread higher in quality, to Tier 1 bank debt, the corporate investment grade sector and elsewhere.
Today, as validation that contagion from Europe’s junk bonds may be spreading, Bloomberg reported that Europe’s primary bond market suffered the latest blow when Dutch lender Van Lanschot Kempen became the fifth issuer to pull a euro-note sale in little more than a week.
The bank postponed the bond sale “due to market circumstances,” spokesman Robin Boon said by phone on Monday. The lender planned to sell as much as 100 million euros ($115 million) of additional Tier 1 notes, the riskiest form of bank debt, according to a person familiar with the matter, who is not authorized to speak publicly and asked not to be identified.
Last week, Volksbank Wien also delayed an AT1 sale – one of two deals postponed the same day – as concerns about Italy’s budget, Brexit and a recent spike in U.S. Treasuries yields have started to erode investor appetite for higher-yielding debt. Still, demand for investment-grade euro notes has been less affected, with Dutch gas distributor Nederlandse Gasunie NV getting orders for almost six times its 300 million-euro deal size on Monday.
Echoing what we said on Saturday, Sebastien Barthelemi, head of credit research at Kepler Cheuvreux, warned that “investors are reluctant to invest in high-risk bonds at current rates,” adding that “the trend is for widening spreads.“
What is odd is that Van Lanschot was rather generous when it approached buyers, and offered a coupon of about 6.5% at guidance in the AT1 sale. Volksbank Wien set a final coupon of 7.375% for similarly-rated AT1s before pulling its sale on Thursday.
Also last week, German maintenance provider Bilfinger SE and payment-technology provider Ingenico Group SA also abandoned euro bond sales, while French lender My Money Bank delayed a €500 million covered-bond sale on Sept. 27.
And while much of the recent weakness can be attributed to the surge in Italian yields, the political turmoil between Rome and Brussels appears unlikely to go away any time soon, which begs the question: between a sudden decline in demand for European junk bonds (driven by both the economic slowdown across Europe and the ECB’s QE taper which is expected to end on Dec. 31), and growing populist sentiment inside Europe’s most indebted nation, is Europe’s bond market about to slam shut?