Europe Shut Down the Riskiest Junk Bonds Due to Increasing Default Risk

Europe_Shut_Down_the_Riskiest_Junk_Bonds_Due_to_Increasing_Default_Risk

The riskiest corporate debt is increasingly posing dangers for investors as signs of a growing default cycle emerge. Recently, the holding company of Thames Water Ltd. failed to meet payments on a £400 million bond ($504 million), while Altice France saw a drop in bond prices last month after announcing “discounted transactions” to reduce its debt burden.

This trend has led investors to penalize CCC-rated debt despite narrowing bond spreads compared to benchmarks. In Europe, the extra yield on the riskiest debt has reached levels not seen since the height of the COVID-19 pandemic and the eurozone debt crisis over a decade ago. A similar but less dramatic widening of spreads is occurring in the US.

For so many years, asset managers have invested in the lowest-rated bonds to enhance returns, assuming that central bank liquidity would prevent widespread defaults. Even then, with interest rates rising rapidly, some companies are struggling to refinance their debt at higher rates, increasing the risk of defaults and potential losses for investors.

Experts such as Raphael Thuin, head of capital market strategies at Tikehau Capital, warn that the effects of recent interest rate hikes are now being felt, with a period of pain expected in the coming months. Central banks, including the Bank of England, have cautioned about the potential widening of credit spreads, particularly for riskier corporate borrowers.

The shrinking availability of bank loans in Europe further exacerbates the situation, with Fitch Ratings predicting a rise in default rates for high-yield bonds this year. Despite this, the spread between different ratings of high-yield debt remains relatively narrow, indicating investor preference for higher-risk bonds while avoiding the riskiest category.

While the CCC-rated debt accounts for only a small portion of Europe’s junk index, recent downgrades of companies like Altice France and Thames Water’s owner, Kemble Water Finance Ltd., highlight growing concerns about unsustainable debt levels.

Other than these challenges, there are still pockets of optimism in credit markets, such as the strong performance of US leveraged loan funds and successful debt offerings by companies like Herbalife Ltd. Still, other companies, such as 99 Cents Only Stores LLC and Acorda Therapeutics Inc., are facing significant challenges, including bankruptcy filings and business wind-downs.

There have been notable personnel changes in the finance industry, including the departure of Viking Global Investors’ head of credit, Patrick Dowd, and appointments such as Christian Roth as Chief Investment Officer of Global Fixed Income at Northern Trust Asset Management.