European default rates set to rise

Founder & Senior Portfolio Manager European Fixed Income Specialist
European default rates set to rise. As a delegate at today’s annual European high-yield conference hosted by AFME, I wanted to comment on the topics discussed. There were a number of panels specifically dealing with the increase in restructurings, restructuring law, as well as positioning and preparing for a significant increase in the number of restructurings in Europe.

The panels and topics discussed are usually a very good leading indicator of what people are thinking in the high-yield market, and the high-yield market itself is usually a very good precursor to corporate irrational exuberance or a good indicator of pessimism, and a commensurate increase in the rate of default.

Obviously restructuring in the oil and gas industry is a very hot topic in the United States with elevated default rates way above 10% in the sector observed over the past year. Speaking with the head of Fitch rating agency a number of themes emerge principle amongst them the fact that there would be opportunities in the near future to pick up deeply distressed or bankrupt companies in a variety of sectors. We take a more proactive view and think there ought to be significant underweights or even short positions in a number of industries and sectors , timing is important before next year one need to consider these positions.

The principal sectors that concern us include obviously oil and gas, investors should focus on the tertiary companies that are involved in ancillary services and that have small balance sheets and are not able to withstand prolonged periods of negative cash flow and reduced Ebita. However brace yourself for an increase in UK retailers restructuring and going into administration … why because they are currently producing meager margins have high levels of leverage, run very tight logistically oriented businesses, and very adversely affected by even small increases in input prices. The 17% drop in sterling will have a devastating effect on this industry, causing a massive increase in input prices in the highly competitive industry with very high levels of leverage and very tight covenant headroom.

The good news is that a number of UK retailers anticipated fluctuations in the currency and have hedged their currency exposure until the summer of 2017. Therefore after these hedges expire, we believe that this will leave many UK retailers highly exposed to massive margin compression a jump in cost of goods sold and that the competitive environment will remain in place causing a number of bankruptcies in the sector.

We focus on European fixed income principally credit, please feel free to write to me at [email protected] with comments or questions