in the high yield markets on both sides of the Atlantic, even though growth
in Europe was stronger, albeit from a smaller base than in the U.S., according
to a report released today by Standard & Poor's Ratings Services. Decreasing
downgrade activity, a visible decline in defaults, and low volatility in the equity market encouraged a continued search for yield among investors with resulting spread compression. The current compression of spreads, however, leaves little room for further gains, and the balance of risks appears on the downside.
The surge in liquidity has also been beneficial for alternative groups--e.g., hedge funds, private equity, leveraged finance--that see an opportunity to make substantial rewards for their investors (among them, banks) by purchasing companies in need of financial or operational restructuring. In Europe, refinancing--and to some extent, financing--needs associated with large leveraged deals were a key factor in boosting issuance volumes in the high yield bond market. "In both regions, a burst of lower-grade issuance has materialized in recent months, sowing seeds of concern about the default outlook two to three years ahead," observed Diane Vazza, head of Standard & Poor's Global Fixed Income Research Group.
Indeed, the search for higher coupons among investors has also driven up issuance in the high-risk 'CCC' rating category (inclusive of 'CCC+' ratings and lower). This bottom tier grew in Europe from no activity to 14% of total issuance in the year to date; in the U.S., its share rose to 12% in 2004 compared with 9% in full-year 2003. Nonfinancial issuers were the primary beneficiaries of the surge in activity in the U.S. and European high yield bond markets, but some noticeable shifts are observable in the issuance trends by sector within each major region. In Europe, fallen angels contributed less to this year's activity than in 2003. The negative bias in the speculative-grade segment in both the U.S. and Europe has declined visibly over the past year, with the proportion of entities listed either with a negative outlook or a CreditWatch with negative implications much lower than a year ago. As of Sept. 30, 2004, however, the proportion of entities displaying a negative bias (27% in the U.S. and 23% in Europe), continued to outpace the share listed with a
positive bias (16% and 11%, respectively) in both regions. Consumer products and transportation--notably airlines--were sectors that were unfavorably positioned in both regions, with a relatively high likelihood of downgrades. Meanwhile, health care and high technology appeared most likely to benefit from upgrades in the U.S., whereas metals/mining, telecommunications, and capital goods were best placed in Europe.
Members of the media only can obtain a copy of the full report, "Liquidity Rush in U.S. and European High Yield Bond Markets," by contacting Marc Eiger at (1) 212-438-1280. The report is listed under Global Fixed Income
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