YEARAHEAD-Euro high yield - Things can only get better

A dire performance in 2000 means Europe's high-yield bond market cannot help but offer investors better returns next year, analysts said on Wednesday - but a reversal of fortune is likely to take time.

They said the primary market, all but closed since early November, was likely to remain dormant until sagging secondary market prices stabilised. Support for high-yield credits has been washed away in recent months by a torrent of negative sentiment towards the dominant telecoms sector in particular.

Merrill Lynch's Euro High Yield index shows year-to-date returns some 20.86 percent in the red. Some argue the market is oversold, however, with prices not reflective of fundamentals.

"At the moment the market is pricing in a higher level of defaults than we will likely see," said Martin Reeves, vice president of fixed income at Alliance Capital. "That therefore implies over an extended period of time we will see excess returns."

Unwelcome surprises for holder of bonds from industrial issuers - notably CP Kelco and Cammell Laird, which is entangled in a contractual dispute with one of its customers - have added to the junk sector's woes.

CP Kelco bondholders appeared on Wednesday to have resolved a dispute with U.S. bank Lehman Brothers over a suitable byuback price for the debt, but bankers said that as soon as one issue fades, another one looms.

Lehman owns 71 percent of U.S. food additives maker CP Kelco and underwrote its 255 million euro September bond issue, the price of which nosedived in November following a third quarter results warning.

Europe may yet end 2000 with a telecoms default, with Esprit Telecom expected to miss a coupon payment due on Friday.

Esprit has $767.05 million Eurobonds outstanding, due December 2007 and June 2008. Parent company GTS said this week it had not decided whether to make the coupon payments or to allow the company to default.

GTS paid bondholders in November for the removal of the cross default clause that made it liable in the event of an Esprit default.


Telecoms companies are likely to remain a key source of issuance in 2001 because of their need to finance expansion, bankers said, but issuing new debt will be expensive until prices in the secondary market bounce back.

"We expect it to be difficult to get telecoms issuance away in the first quarter," said Helen Rodriguez, head of European high-yield research at Deutsche Bank.

"This will make people focus on the secondary market and tilt the balance of supply and demand in favour of demand, hopefully having a beneficial effect on sentiment."

But a real improvement will take time unless the sector is boosted by positive credit events such as strong results and acquisitions of smaller telcos by more established players.

"Maybe the second half of next year will be better, but for the next three to six months, I'm expecting slow going, gradual improvement and muted activity," said Tom Connolly, head of European high-yield at Goldman Sachs.

"For the market to really pick up you need telecom activity. I just think it's going to take a long time for the market to rally so much that (we'll see) a lot of telecom activity."

External factors could speed a recovery, however, with U.S. interest rate cuts and a Nasdaq recovery, which would boost U.S. high-yield activity, having a knock-on effect in Europe.

"Any sustained recovery in European high-yield really does need to be accompanied by an improvement in U.S. high-yield markets," said Christoher Garman, global high-yield strategist at Merrill Lynch in London. "The European high-yield bond market moves fairly well in step with U.S high yield."

INDUSTRIAL ISSUERS WILL ARRIVE...EVENTUALLYInvestors looking to diversify out of telecoms may find more to cheer about in 2001. Leveraged buy-outs in the industrial sector are likely to lead to a string of deals next year, bankers said.

Timing will be contingent on price stabilisation or recovery in the secondary market, as with telecoms issuers, but the scarcity of LBOs should guarantee investor attention.

"Certainly things seem to be heating up quite radically on the LBO side in terms of actual companies for sale," said Rodriguez at Deutsche Bank. "That points to the possibility of much more activity from the second quarter onwards for the industrial side."

Double-B rated industrial deals, a rare sight in Europe, may take longer to emerge, however, as many companies in that bracket still enjoy favourable lending rates from banks.

European banks are coming under increased cometitive pressure, however, and changes to regulations dictating how banks provision for credit risk could accelerate change, said Merrill's Garman.

"The fact of the matter is that capital markets price risk more effectively than banks do, and that means the long-term trend (for BB-companies) should be towards the capital markets," Garman said.

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