Europe's Junk-Bond Boom Triggers Alarm as Safety Nets Weakened

Europe’s booming junk bond market is provoking alarm among analysts who say investors are letting down their guard and risking future losses.

Dutch department store operator Hema BV, home improvement retailer Maxeda DIY Holding BV and supercar maker McLaren Group are the latest in a string of companies that have sold bonds with weaker investor protections, known as covenants, and with more loopholes written into the documents that govern the debt.

Typical covenants ban a company from taking actions that could weaken the chances of a bond getting repaid, such as heaping on more debt, pledging assets to other lenders or transferring control to new owners. Penalties can be harsh, with creditors entitled to demand costly fees as compensation or even immediate repayment of the bond’s entire value.

Covenant Review said before the deals priced that it can’t “overemphasize the importance of investor resistance” to some of the new deals’ terms. Lucror Analytics recommended that investors push back against the proposed documentation for both Hema and Maxeda or, at least, demand more compensation. Moody’s echoed the concerns in separate reports.

Yet investors can’t seem to get enough of Europe’s riskiest offerings. Companies sold 1.7 billion euros ($1.9 billion) of notes with ratings of at least seven levels below investment grade -- or five levels above default, among the lowest available. That’s already the most for a full month in more than two years, the data show.

The whole European junk bond market is on track for the busiest July on record, whereas issuance in the U.S. is waning. So far this month, sales swelled by 400 percent from the same period last July, while equivalent U.S. offerings dropped about 75 percent, Bloomberg data show.

McLaren even managed to increase the size of its debut bond offering on Thursday to the equivalent of 564 million pounds ($737 million) after initially offering 525 million pounds of notes. Maxeda issued 475 million euros of bonds and United Group sold 1.35 billion euros of notes in three parts on the same day. Hema issued 750 million euros of notes on Friday.

A representative for McLaren declined to comment while spokespeople for Hema and Maxeda weren’t immediately able to comment. A spokesman for United Group wasn’t available.

There has been some successful pushback. Investors forced Italian cleaning contractor Manutencoop Facility Management SpA to improve the terms and reduce the size of its junk bond offering on June 29. They also managed to change a covenant on a bond sold by U.S. car-part maker Superior Industries International Inc. earlier last month.

Nor are these warnings about complacency in markets the first. The Association for Financial Markets in Europe, a trade group representing all market players, has asked borrowers to spend more time discussing their capital structure and covenants -- particularly if they have unusual terms -- and for investors to get to ask the pertinent questions.

But fewer protections should be translating into more compensation for bondholders and here’s the rub: European high-yield bonds are paying near the least on record.

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