Please do not stop the music.

In recent days, the European high-yield market has experienced a surge in issuances, despite navigating two primary headwinds: geopolitical tensions and interest rates movements. On the geopolitical front, markets have become relatively accustomed to ongoing conflicts, such as the Russia-Ukraine war and tensions in the Middle East. These are often perceived as transient, with limited long-term impact on broader equity performance (particularly in large-cap stocks) and credit fundamentals. Portfolio managers have adapted to local geopolitical risks by increasing their expo-sure to gold, a shift reflected in the metal’s performance over the past 24 months, during which its traditional relationship with interest rates has decoupled.

Regarding interest rates, the 10-year U.S. Treasury yield has risen by 65 basis points since the Federal Reserve’s last rate cut, while the 10-year German Bund yield has climbed by 18 basis points following the ECB’s third-rate reduction of 2024. During the ECB’s Monetary Council meeting on October 17, the outlook indicated that Europe remains on track for a likely soft landing, despite underwhelming business activity and sentiment indicators. Europe, however, continues to grapple with structural challenges, such as high energy costs and low competitiveness, which add complexity to economic recovery efforts.

Against this backdrop, European credit markets have shown notable resilience, with demand for assets remaining strong and even increasing as we approach year-end. As discussed previously, inflows into investment-grade (IG) and high-yield (HY) European funds, along with the influence of exchange-traded funds (ETFs) and collateralized loan obligations (CLOs), play a significant role in shaping credit market dynamics.

The stabilization of government bond curves has bolstered the risk-on sentiment, even as long-term rates rise (direction is less important than volatility). These factors impact credit yields from initial price thoughts (IPT) to final pricing conditions in the primary market, affect repricing for existing loans and bonds, and influence secondary market trading levels. While documentation in deals frequently leaves room for improvement, key amendments are often negotiated by a few prominent funds and investors in collaboration with equity sponsors and bookrunners - a trend made more evident after the excesses seen in 2020 and 2021.

The European credit market has undergone three significant repricing waves, and my current view remains consistent with previous analyses on CLO vintages and equity returns. These repricings have had a marked impact on certain portfolios, particularly on structures with two-year no-call periods priced in mid-late 2023. Vehicles “out of the RP and run with no margins on the rating matrices” experienced similar challenges. Weighted average spreads for many vintages have tightened by several basis points beyond the forecasts of some optimistic research firms back in January 24, due to miscalculated or flawed repricing assumptions on the leverage market. Where repricing waves had minimal impact on CLO portfolios, CLO paper investors may find it beneficial to examine changes in the Weighted Average Rating Factor (WARF) over the past year, as well as the quality composition of portfolio assets. How did the portfolio change under manager’s direction independent of external factors? And the combination of multiple forces modifying the characteristics and composition of the assets?

Portfolio managers are resetting their vehicles when feasible, though the total weighted average cost of liabilities remains around E+210/220 basis points while CLO assets find a floor only around E+350 basis points. Reset exercises remain challenging in some cases due to the mixed quality of underlying pools. Some portfolios are being liquidated, with multiple factors contributing to these decisions.

The number of troubled credit names in Europe has remained steady over recent months. With the possibility of economic downturns and shifts in the ratings landscape, it’s important to observe how CLO managers handle these assets and the accompanying price fluctuations. This will provide insight into whether CLO platforms are viewing asset price corrections as opportunities to identify attractive names and build par, or if they are exiting these credits to preempt and avoid a deterioration in portfolio metrics (with possible par destruction). Meanwhile, passive CLO managers can expect more inquiries from experienced investors regarding their credit approach. I addressed this topic in a previous post that discussed evaluating a CLO platform as a whole, rather than concentrating on individual vehicles and their often partial or misleading metrics.

In the European bond market, recent issuances have catered to diverse investor preferences, spanning ratings from CCC to BB+, covering sectors from restructured retail to sustainable infrastructure, and including both debut and established issuers. Floating Rate Notes (FRNs) remain popular, given their suitability for CLOs. Not all financings appeared mispriced, even considering longer maturity profiles, with certain names offering strong returns and favorable value relative to their risk and comparable. Debut issuers do not offer a relevant premium for their (unknown) credit qualities and price at the tight end of the fair value, suggesting a misprice of 40/50 bps on average. When discussing those new deals, I feel investors decide to allocate money more for diversification than a strong conviction.

Technical support for liquid credit assets remains strong (the surge in structured credit volume in 2024 is remarkable after years of stagnation), while private credit is still navigating its place in this unique market environment.

In discussions with investors, I occasionally observe complacency towards weak credit metrics and low cash flow generation, with the 10% yield threshold proving highly attractive. In other cases, investors tend to evaluate certain names with outdated or overly cautious perspectives, tied to prior complex credit histories and performances.

I continue to emphasize that current market conditions differ significantly from past cycles. Companies evolve, and sector dispersion should be regarded as an opportunity rather than a risk. Credit Default Swap (CDS) players are increasingly shaping amend-and-extend (A&E) and liability management exercises (LMEs), while volatile earnings in certain sectors continue to reflect adjustments from unrealistic post-pandemic trends. Some struggling companies are reliant on unsustainable revenue projections, unattainable EBITDA margins, low capex levels, and working capital contributions to cash flows, which can only obscure their true condition temporarily. Several recent financial results of European borrowers illustrate these trends.

While certain “adjusted” capital structures and A&Es may provide issuers and investors with some leeway, unsustainable balance sheets and shifting consumer habits ultimately determine the winners and losers in the credit landscape. Drawing strong conclusions at this stage is difficult. Exercising caution with higher-quality credits (I do not use “defensive positioning” because it means nothing), especially as we enter November and with U.S. elections on the horizon, seems a prudent strategy.