Selectivity pays as European high yield hits record

Primary issuance in the European high yield (HY) market surged in June with €21.2bn of supply marking the highest monthly volume on record. Following an active May, this also took Q2 volume to a new quarterly peak of €42bn, surpassing the prior record of €41.3bn set in the second quarter of 2021. Investors have shown strong appetite for new issues, with deals often ending up multiple times oversubscribed despite final pricing tightening in considerably from initial price thoughts (IPTs).

After muted levels of net supply (new issues minus maturing bonds) for much of the past 18 months, new deals accounted for some 70% of the €21.2bn record figure for June with the remaining 30% being refinancings. We have also seen more aggressive offerings, with a surge in dividend recapitalisations (whereby a company raises new debt to pay a dividend to shareholders) and payment-in-kind (PIK) deals, which enable borrowers to defer interest payments by issuing more debt instead of paying cash. Dividend recaps alone accounted for a 12% share of proceed use, representing the largest proportion of dividend-related deals since 2019 and substantially greater than the average share of 2% over this period. CCC-rated issuance also made a comeback for the first time in almost a year this week, with Flora Food Group printing a six-year senior unsecured note at 8.625%.

Despite the deluge of fresh paper, demand has been underpinned by strong and continuous inflows into European HY funds over the last few quarters. Competition for bonds has driven the coupon on new deals down to the tighter end of IPTs during the bookmaking process, and has also encouraged more companies with near-term refinancing needs to come to the market now. Elevated levels of risk appetite for HY bonds reflect the risk-on sentiment that has materialised across credit in recent weeks, giving issuers confidence that market conditions are right to raise fresh capital and refinance maturing debt.

While net supply has increased significantly, the technical backdrop has remained supportive for spreads. With fund managers generally long cash and positioned “cleanly” (i.e. the market is generally underweight CCC paper and not overly long beta), spreads have continued to tighten, aided by softened tariff fears. This has naturally driven some notable pricing compression between single- and double-B rated European HY. The B-BB spread differential tightening by over 30bp in the last two months, indicating investors are accepting less compensation for lower credit quality (see Exhibit 1).

While we are encouraged by how well the market has taken down supply in recent weeks, and view this as a strong indicator of a well-functioning and resilient HY market, we believe selectivity pays. With elevated macro uncertainty and tight spreads, we view this market as a good one for credit pickers and not one to be blindly moving down the quality spectrum; the Flora Food Group bonds mentioned above priced at par earlier this week and at time of writing are trading two points lower. Our focus continues to be on businesses with strong balance sheets and robust cash flow.