Is the dry spell in European high yield (HY) refinancing activity a harbinger of an increase in credit defaults? We do not think so and have already seen some reopening, but here is what we are watching and how we are positioned.
Credit investors keep an eye on refinancing activity because the inability to refinance is a key driver of defaults. The recent dry spell in European HY primary markets was the longest period since the depths of the eurozone sovereign debt crisis in 2011. On April 25, the spell was broken by the announcement of a well-choreographed £815 million deal.
As a result, market estimates of default rates have risen notably. The trailing 12-month European HY expected default rate could rise from just over 1% at the end of Q1 2022 to 8-10% in a pessimistic scenario.1 However, a significant proportion of this is driven by emerging market (EM) European HY issuers, where the expected default rate has increased from 0.7% to around 18-19% primarily due to credits exposed to Russia and Ukraine.2 For perspective, excluding EM European HY, default estimates for developed market (DM) European HY are only 1.1% and account for up to 95% of the European HY universe.3
In our view, the lack of refinancing in DM European HY needs to be considered in context. First, geopolitical uncertainty and a general risk-off tone has dampened market appetite and issuance activity. Second, DM European HY companies have generally been successful in refinancing maturities at low interest costs, meaning that there is little upcoming issuance that is critical, even into 2023.
We acknowledge that risks stemming from the current lack of refinancing are rising, but looking more closely at refinancing needs, we expect the risks will be more relevant in 2023 and beyond, rather than in 2022. Only €6 billion, or 1.3%, of European HY debt needs to be refinanced in 2022 and only €2 billion, or 0.4%, is debt from issuers that are rated lower than BB. €2.7 billion, or 0.6%, is debt issued by companies rated investment grade (IG) and should have better access to markets that have been functioning well and had steady issuance over this period. EM European HY, where concerns around implications of the war in Ukraine are most acute, accounts for only 2.7% of the European HY benchmark.
We believe defaults could rise in 2023 if macroeconomic conditions, including supply chain issues and inflationary pressures, do not stabilize. At that time, 8.5%, or €39 billion, of European HY corporate debt, will need to be refinanced, of which 6.5% is rated higher than BB. Key sectors where default activity could trend higher are Packaging/Glass (2.8%), Leisure (5%), Retail (2.4%), High Tech (2.6%), according to Moody’s estimates.
In light of these potential future refinancing risks, we are selective in our exposure. Our Global HY and European HY funds have 3% and 7% market value underweights, respectively, to bonds that will mature in 2022 and 2023, and we remain focused on company-specific dynamics. We also have minimal exposure to EM HY, including EM European HY, which, as a result, represents meaningful underweights to the benchmarks.
While we do not believe a rise in European HY defaults is imminent, we are monitoring the situation closely and are positioned accordingly for the risk and the possibility that further dislocation could create opportunity.
Each month we feature quotes from our investment team, offering a glimpse into our investment views and what we are monitoring and analyzing.
“European High Yield Corporate Treasurers continue to display highly conservative behaviors. For example, cash buffers now sit at 30% of balance sheets – all-time highs.”
Fiona Macnab, European High Yield Portfolio Manager
Goldman Sachs Asset Management | April 2022
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