Junk bonds on the rise as issue hits €20bn high in Europe

Bonds issued by lowest-rated companies already more than double last year's total

• Elena Moya
• guardian.co.uk, Monday 26 October 2009 16.59 GMT
• Article history

The junk bond market, or bonds issued by the lowest-rated companies, is booming in a sign that appetite for risk is back in the financial sector.

Junk-rated European companies, such as Virgin Media and ITV, have issued bonds worth a combined €20bn (£18bn) so far this year, up from the €7.5bn (£7bn) issued in the whole of 2008, according to Fitch ratings agency.

The re-emergence of junk bonds, which were pioneered in the 1980s by the legendary Wall Street financier Michael Milken, has been a crucial lifeline for businesses who saw banks retreat from lending in the wake of the credit crunch.

Investors are in turn flocking to the more risky high-yield market because of the low returns offered elsewhere with interest rates at historic lows. They are attracted to returns of about 7 or 8%, compared with the 3% they get from a more regular loan.

However, Standard & Poor's, another ratings agency, warned that the rush back into junk products could be dangerous. "Are memories in the capital markets getting shorter? The global markets have just experienced one of the worst liquidity and credit dislocations since the Great Depression ... We believe that investors might want to consider the benefits of maintaining discipline in structuring, pricing, and distributing high-yield bond transactions," the company said.

A high-yield conference in London last week saw about 200 bankers, investors and corporate treasurers gather to cheer the return of a market that still represents a small fraction of the funds raised by European companies.

Traditionally, businesses in Europe have relied more on bank loans built on longstanding relationships and local contacts. But banks are still shoring up their books in the wake of the credit crunch and have turned down some of their traditional clients. Slowly, the European high-yield market is turning more towards a US model, more reliant on institutional investors, such as pension or hedge funds. The US, with an economy similar to Europe's, has a junk bond market which is about four times bigger.

"The European market was very one-sided, it's healthier to have a balance," said Nick Jansa, head of European loans and high yield at Deutsche Bank, on the sidelines of the European High Yield Association conference. "You don't want to walk into a shop and only have one product."

A high-yield bond offers companies longer maturities than a traditional three-year bank loan, which has to be refinanced. Also, junk bonds can have looser covenants, giving businesses more room to breathe.

"We looked at our capital structure holistically, and although we have excellent relationship with our banks, it was good to diversify," says Rick Martin, director for treasury and investor relations at Virgin Media. The company raised £1bn through a junk-bond issue in the summer. "It was natural for people to gravitate to bank debt because it was cheapest, but the world has changed, and when availability of bank debt is not what it was, then people have to look for alternative sources."