The European high yield market currently has €221bn of debt outstanding in the BB-rated space, representing 70% of the BofAML European High Yield index. If you look at the amount of debt that has fallen into the European high yield space on any 12-month rolling period historically, there was close to €100bn over the 2008 global financial crisis, €80bn during the European peripheral crisis in 2011 and just over €60bn in the 2015 market sell-off. It is therefore not unreasonable to expect anything from a 25% to 75% increase in the size of the Euro high yield market over the next 12 months; some investment banks have even estimated a doubling in size! Some of the largest constituents in the BBB-rated space are Volkswagen, Deutsche Bank, Bayer and Renault. Due to the large volume of bonds these companies have in circulation, a drop in credit rating could trigger a big impact in the market and composition of indices.
Where a company does see a drop in credit rating to high yield, it’s valuable to think about what this does for its funding costs (expenditure associated with raising capital in the market). It’s not quite as simple as saying they will rise dramatically; there are a number of moving parts to consider. A vast number of companies at risk of downgrade require their investment grade ratings to receive government support in times of crisis. But in some instances, we have seen governments still lending a helping hand. The German government provided a €2bn loan to BB-rated travel operator TUI this week, the proceeds of which will be used to increase the company’s existing credit lines. We have also observed some companies split their capital structures across both investment grade (bonds are secured on collateral) and high yield (bonds are unsecured, repayment relying on the full faith and credit of the issuer) such as T-Mobile/Sprint and Charter Communications. Nevertheless, while higher quality issuers will be welcomed in the high yield space (as we have most recently seen with Kraft Heinz and Ford), it is worth reminding ourselves that not all companies will see such strong marginal buyer support.