Elevated inflation and interest rate hikes in Europe and the US, coupled with the events in Ukraine, have taken a toll on high yield bond activity in the first half of 2022.
In Asia-Pacific, another wave of COVID-19 restrictions in China and the ongoing fallout from financial distress in China’s real estate sector (historically one of the major sources of APAC high yield issuance) have cooled sentiment in the region’s high yield space.
High yield bond issuance in Western and Southern Europe declined from US$106.8 billion in H1 2021 to US$31.1 billion in H1 2022. High yield bond activity in the US has been hit even more aggressively, falling from US$267.6 billion in the first half of 2021 to US$63.6 billion in the corresponding period this year.
The high yield space has also been muted in APAC (excluding Japan), with issuance tailing off from US$60.8 billion during the first half of last year to US$12.6 billion in H1 2022.
Rising rates take their toll
Inflationary pressures in Western markets have obliged central banks in the US, UK and Europe to pivot away from dovish monetary policy and move to raise interest rates.
In the UK, benchmark rates have been lifted to 1.25%, the highest level since 2009. The European Central Bank raised rates in July for the first time in 11 years. In the US, meanwhile, the Federal Reserve has upped its benchmark lending rate four times since the start of the year, to a range between 2.25% and 2.5%.
The rate hikes have had a direct impact on high yield bond activity. As fixed-rate instruments, high yield bonds have been less appealing to investors when compared to leveraged loans, which have floating rates and pay out more interest when rates increase. Growing concerns that hawkish monetary policy could lead to a recession has also knocked high yield markets in Europe and the US, which have had to contend with more volatility.
In response to rising rates, European bond issuers have come to market with floating—rather than fixed—interest rate bonds. The percentage of European high yield bonds raised as floating rate notes has climbed from just 8% and 12% in 2020 and 2021, respectively, to 18% in 2022 so far.
Even with these attempts to sweeten deals, European high yield markets have battled to build momentum. According to Debtwire Par, approximately half the issuance this year took place in January, before inflation concerns, rising energy costs and events in Ukraine intensified.
Since then, the market has battled to find direction, with activity in Europe showing double-digit year-on-year declines across new money deals, refinancing, buyouts and M&A issuance. Refinancing activity has been hit especially hard, with investors noting the deep discounts to par for outstanding debt in the secondary market and preferring these trades over refinancing opportunities.
As secondary market pricing has declined, yields on European high yield bonds widened from 4.2% at the start of Q2 2022 to 6.9% by the end of June.
For issuers who have braved the market, financing costs have escalated, with weighted average yields rising to 6.83% in Q2 2022, up from 5.3% in Q1 2022 and 4.73% in the final quarter of 2021.
Real estate weighs on APAC
In APAC, issuers and investors have been navigating wide discounts to face value for outstanding high yield bond debt in the secondary market. The Chinese real estate high yield bond market—long the cornerstone of the region’s high yield space—has been especially squeezed after slowing growth and tighter leverage controls saw several real estate defaults.
For smaller APAC markets, however, the silver lining from distress in Chinese real estate is that investor attention turns to other opportunities in the region. According to Bloomberg, the discounts to par for Indian and Southeast Asian high yield bonds have been much narrower than the APAC average, with prospects for rising issuance in the second half of 2022 as a result.
Chinese issuers are still expected to account for the bulk of high yield issuance in 2022, but the country’s market share has slipped to 61% of high yield bond issues this year, down from 76% in 2020 when the distress in the real estate began to emerge.
New pockets of activity will fill some of the gap, with areas such as Indian green debt—which will fund the country’s plans to cover half of its energy requirements from renewables by 2030—one of the growth areas capturing investor attention.