The credit countdown clock is ticking

Credit markets still offer opportunities, but borrowers need to act quickly.

The European credit markets are having a jumpy year. Early 2018 seemed to be the best of times for European credit. Spreads over government bonds continued to tighten for most borrowers and issuance volumes picked up pace after a slow start, with a near record €80bn issued in one four week stretch in the first quarter. Then confidence suddenly took a turn for the worse. Spreads widened, as fear of the impact of withdrawal of central bank easing policies coincided with renewed global trade tensions to undermine sentiment.

The start of the second quarter saw some calming of nerves among both investors and borrowers.
But the countdown clock is clearly ticking for a market that had offered near-perfect conditions.

It is unlikely that spreads will tighten sharply and absolute returns for credit may be disappointing if interest rates continue to move up. And borrowers can expect closer scrutiny of their credit quality, while being forced to keep an eye out for opportunistic M&A-related bonds that are priced to sell quickly and soak up investor demand. But well-timed and properly structured bonds will continue to thrive, according to Societe Generale, which was the number one ranked issuer of all international bonds denominated in euros in the first quarter of 2018.1

“Debt advisory services will be more important than ever for borrowers as market conditions become more challenging in the rest of the year, we nevertheless expect strong demand for well priced deals that are distributed to a wide range of investors.”

- Demetrio Salorio
Global Head of Debt Capital Markets at Societe Generale CIB.

The fundamentals of the European credit markets remain strong, which should help borrowers to maintain the flow of new issues. Moody’s forecasts that the European speculative-grade default rate will fall to 1.2% by the end of this year, for example. That is significantly lower than the projected speculative-grade global default rate of 1.9%, which is itself exceptionally low. And some reasons for recent global credit market strains apply less to the European debt capital markets than to other regions.

1 Source: IFR League Table, 1/1/2018–31/3/2018

European M&A volume is picking up sharply, and driving substantial debt issuance. But there are few bonds that are so big that they cause disruption to markets, in contrast to some mega-deals from US borrowers that have been in the tens of billions of dollars.

The volatility in technology sector prices that has been a feature of equity market movement in 2018 has a limited impact on the European credit markets, where tech is a smaller sub-set of debt issuance than it is in the US.

Europe is also not the focus of the recent global trade tensions that have developed into a war of words and tariff threats between the US and China, though no region will be immune from any significant deterioration in trade conditions.

European credit market spreads over benchmark bunds retraced some of their widening early in the second quarter, and debt issuance volumes have room to grow, depending on the sector. Corporate bond issuance in the first quarter of the year was lower than during the same period in 2017, for example, but the trend reverted in April with investment grade European debt volumes more than twice as high as in the same month in 2017.

Investment-grade non-financial corporate bond issuance in the first quarter of this year was almost €70bn compared to just over €93bn in the same period of 2017. High-yield supply has been similar to 2017, with almost €20bn of issuance in the first quarter in each of the last two years.

Financial sector issuance is up slightly, with senior financial flow rising from €50bn in the first quarter of 2017 to €57bn this year, and subordinated deal totals edging up from around €13bn in 2017 to €14bn in the first quarter of 2018. The European credit markets have enjoyed a long run of positive performance for investors and borrowers alike. That means a further sharp rally after such an extended multi-year run may be unlikely.

But borrowing conditions remain appealing for debt issuers with advisers who can gauge demand, judge timing and pricing conditions, have a global view on potential new issue pipeline, and distribute new deals to a wide range of investors.

As the credit market countdown clock runs down further, taking advantage of funding opportunities on a timely basis will be key for borrowers of all types.

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