Stockholm (HedgeNordic) – The Nordic corporate bond market has grown meaningfully in recent years, as companies have been turning away from traditional bank lending due to difficulties in obtaining funding from banks. Since many Nordic issuers are too small to find the expensive and resource-demanding official ratings suitable, much of the just-mentioned growth has come from the unrated segment of the Nordic corporate bond market. With more than half of all issuers in the Nordic corporate debt market having no official ratings, should investors be concerned about a potential pick up in default rates? How have Nordic high-yield rated and unrated bond issuances performed in recent years?
The Nordic corporate bond market and the dilemma of unrated debt
According to data provided by fund management boutique Evli, there is an estimated €225 billion in bonds outstanding in the Nordic non-financial corporate bond market as of the end of September 2018, a market currently comprised of 480 issuers (figures reflect only issuers with amount outstanding in excess of €30 million). The size of the region’s corporate bond market increased from €192 billion at the end of 2015 to €205 billion at the end of last year. The number of Nordic issuers, meanwhile, rose from a total of 430 in 2015 to 480 issuers at the end of September of this year.
Around 54 percent of the 480 issuers do not have official credit ratings and roughly 29 percent of the €225 billion in bonds is unrated. Nordic non-rated issuers are estimated to offer an excess yield of 50 to 150 basis points more than their rated European peers, representing a risk premium for the absence of credit ratings rather than higher risk or insufficient liquidity. Many Nordic firms are small, and their average issue volumes are not large enough to turn the resources required to receive an official rating into a good investment. Official ratings allow issuers to receive cheaper funding, but the upfront fees and annual maintenance fees paid to rating agencies can more than offset the benefits of an official rating when issue volumes are small and infrequent.
Hidden gems and lemons
In mid-September, Swedish telecom operator Tele2 received a ‘BBB’ credit rating from S&P Global Ratings, the lowest rung of investment grade. Danish logistics provider DSV, meanwhile, was assigned an even stronger rating of ‘BBB+’ a couple of days later, yet another piece of evidence of good quality issuers among companies with financing needs in the unrated corporate bond market. Partly because of the abundance of unrated issuers, some Nordic funds focus on the crossover segment of the corporate bond market. This segment contains corporate bonds that, as a group, offer higher yields than most investment-grade bonds, yet have less or similar credit risk than some investment-grade bonds.
“If issuers do not have an official rating, many investors treat those as high-yield by definition,” Petter von Bonsdorff, Head of International Business Development for Evli’s funds, tells HedgeNordic. “But in reality, unrated does not automatically mean high-yield. That creates opportunities for an active manager,” he adds. Many fund managers look for hidden gems in this segment. But there are lemons too.
Dutch provider of mobile phone cards Lebara has been making headlines in recent months. The SIM-card company raised €350 million in capital through a bond issue in the Nordic bond market in the August of 2017, but the bond is trading at distressed levels after the company suffered a string of financial reporting issues and faced market concerns over its profitability. Lebara has not defaulted just yet, but many issuers have.
Default rates in the Nordic high-yield corporate bond market
In the global corporate bond market, only two investment-grade firms have defaulted since the beginning of 2010 (one of which is US-based futures broker MF Global which filed for Chapter 11 bankruptcy protection in 2011), data from Standard & Poor’s Global Ratings reveal. Defaults in the higher-risk speculative-grade corner of the Nordic corporate bond markets, meanwhile, have been a more frequent occurrence.
According to data provided by Stamdata, the leading provider of reference data for debt securities in the Nordic markets, there is a total of 353 defaulted bond issues since the beginning of 2008, approximately 41 percent of which occurred during 2015 and onwards. 28 bond issues defaulted this year alone by the end of September, compared to 48 defaults recorded last year and a yet higher figure of 50 in 2016. Despite the historically high number of bond issues defaulting, the total volume of high-yield debt defaulting has not been equally high.
The trailing 12-month speculative-grade default rate closed at 2.19 percent at the end of September, which implies that a little more than two percent of the €60.62 billion (NOK 570.42 billion) in rated and unrated high-yield bonds outstanding in the Nordic countries at the end of September last year defaulted. The Nordic market of high-yield corporate bonds has been navigating a though period starting with 2014, as defaults and restructurings hit the Norwegian energy sector as a result of plunging oil prices. The trailing 12-month speculative-grade default rate closed at 3.12 percent at the end of 2014 but increased to 4.50 percent at the end of 2015 and a much higher default rate of 8.02 percent at the end of 2016.
The Norwegian high-yield market, dominated by companies operating in the energy sector, has been hit particularly hard due to the collapse in oil prices. The trailing 12-month default rate in the Norwegian high-yield market was hovering around or above the ten percent-level throughout 2016 and 2017, reaching a high of 19.57 percent at the end of July in 2016. Around 5.59 percent of the €20.16 billion (NOK 189.75 billion) in Norwegian high-yield bonds outstanding at the end of September of last year defaulted. However, Gustav Fransson, portfolio manager at Coeli Asset Management’s fixed-income funds, reckons that “the Norwegian energy high-yield sector is currently out of the woods to some extent. The tide has turned in the Norwegian market as oil prices have risen and companies with weaker balance sheets have been acquired,” Fransson tells HedgeNordic.
The defaulted volume of high-yield bonds issued by Swedish issuers has been significantly lower in the past several years. Out of the €11.06 billion (NOK 104.08 billion) in high-yield bonds issued by Swedish firms that were outstanding in September of last year, only 1.38 percent defaulted as of the end of September. The trailing 12-month default rate among Swedish issuers reached a high of 4.43 percent at the end of October in 2013.
Expectations for default rates in the Nordic high-yield corporate bond market going forward
Amid rising interest rates and ballooning levels of debt, the evolution of default rates in the past several years may give some comfort to credit investors at the moment. Several Nordic fund managers running vehicles investing in Nordic corporate bonds and other specialists with in-depth knowledge of the market do not anticipate rising interest rates to lead to a spike in debt defaults. As Petter von Bonsdorff tells HedgeNordic, “deteriorating company fundamentals are the root of defaults.”
Bonsdorff used Norwegian producer of publication paper Norske Skog, which filed for bankruptcy at the end of last year, to illustrate that fundamentals represent the primary cause behind defaults. “No one reads printed newspapers anymore, and the company went bust.” Gustav Fransson, portfolio manager at Coeli Asset Management’s fixed-income funds, corroborates Bonsdorff’s view. “Defaults tend to cluster in certain industries affected by external developments such as the decline in oil prices, which affected offshore shipping companies and other companies in the Norwegian energy sector,” Fransson tells HedgeNordic.
Rising interest rates are not anticipated to lead to defaults in the Nordic high-yield corporate bond market in the near term, but higher rates may have secondary-round effects on Swedish real estate firms exposed to inflated real estate prices, reckons Bonsdorff. Both Stefan Wigstrand, fund manager of Catella Nordic Corporate Bond Flex, and Gustav Fransson seem to agree. “Companies will face no difficulties in meeting their interest payments, yet companies may default because of reduced refinancing options as leverage has come up quite significantly,” Wigstrand tells HedgeNordic. “The debt owed by some Swedish real estate developers is maturing in the next couple of years, and the may have a hard time refinancing the debt,”says Fransson. “Some of these companies started construction, but have only sold between 60 percent and 80 percent of condominiums,” he adds. With lower property prices and the subsequent decline in demand for real estate from already-indebted Swedish households, real estate developers may end up defaulting.
Picture: (c) By-William-Potter—-shutterstock
