LONDON (Reuters) - There is a risk of a bubble forming in Europe’s high-yield bond market as investors pile into risky deals without understanding the risk of defaults, an industry expert said at a Reuters summit on Wednesday.
"The high-yield market is doing exactly what the loan market was doing in 2007," said Simon Davies, managing director at Blackstone BX.N at a Reuters restructuring summit, as strong demand continues to compress spreads.
Supply is being driven by a mountain of leveraged loans that needs to be refinanced as banks repair their balance sheets.
Market estimates for leveraged loan and high yield bond refinancing in Europe from now until 2017 range from 300 to 500 billion euros ($416-$693 billion), according to Standard & Poor’s.
Meanwhile, demand from investors is increasing as funds chase yield in a low-interest-rate environment. French convenience food company Picard’s 300 million euro note, which partly financed the buyout by Lion Capital, for example, offered a coupon of 9 percent when it priced last month.
“There is too much short-termism. People want yield and they want it now,” said Davies.
The high-yield bond market has seen record supply over $35 billion this year despite volatility sparked by the euro zone’s sovereign crisis that caused primary markets to shut down for several weeks.
“The increase in the volume of transactions is quite stark and would suggest that should it continue we could have a bubble-like problem within the high-yield markets,” said Davies.
The probability of default for an issuer rated B- over three years is about 15-17 percent, while for a CCC-rated credit the default risk rises to 20 to 30 percent over the same period, he added.
“Statistically, about 1 in every 5 to 10 deals getting done in the capital markets now could default. People are putting money to work based on yield, and not cash flows or any thought about when they will get their principal back.”
Davies questioned whether there were sufficient checks and balances in the system.
“If you leave yourself behind in this market, as a corporate (issuer) you’ve still got your maturity problem, as an investment banker you’re making no money and as a high-yield fund your assets under management are either going to sit as cash or will diminish as other funds put money to work.”
Davies pointed to Italian yellow pages group Seat Pagine Gialle's PGIT.MI 200 million euro bond issued earlier this month.
“Directories businesses have got to be in run-off. They are competing with the likes of Google, and demand for paper directories is falling.”
A planned 450 million euro deal from German auto parts after-sales group Auto-Teile Unger (ATU) also looked risky, he said.
“They are stretching the market with that deal. ATU has come off the edge of a cliff,”” said Davies.
(Reporting by Natalie Harrison; Editing by Louise Heavens)
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