European High Yield Credit Research -  January 2006

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Introduction Our 2006 High Yield Handbook is similar to the 2005 version but with an increased number of credits covered and the addition of our 2006 Market Outlook. In 2005, we expanded our single-name research coverage to comprise roughly 90% of the European market in the BB-CCC spectrum while at the same time focussing increasingly on structural and technical factors affecting price action. Notwithstanding the current market trend, our analyses and publications remain fundamentally-driven, involving detailed company and sector assessment and frequent dialogue with issuers and investors. A glance through the pages that follow suggests that the European High Yield market is alive and well. Investors in European high yield have enjoyed 3 consecutive years of positive returns; despite the increasingly LBO-dominated new issuance, the European market has never seen the diversity (in ratings and sectors) it currently enjoys and the number of market participants (mutual funds, hedge funds, underwriters) continues to reach new highs. Moreover, despite all the talk of the shortening economic cycles this credit cycle appears to be moving forward arduously (or mercifully) slowly. Our bottom up assessment of the credits in the market gives us little cause for panic; conversely, we find it hard to find a significant number of bad apples. All this good news would suggest that the market is primed to disappoint soon, and looking at the balance of risk and valuations, risk aversion would not be an unreasonable reaction. Credit spreads are not far from their all time lows of early 2005 and by any measure absolute yields are dismally low. The current market population is dominated by the 2003-2005 vintages whose successful performance leaves the majority of bonds dangerously high in price terms, when considering the likelihood of increasing European government bond yields and the picture-perfect execution implied by credit spreads. Given the slim pickings, investors will be increasingly dependent on new issue performance to earn returns respectable enough to warrant exposure to junk-rated credit. The environment therefore seems opportune for a slow but steady separation of high and low quality credit, and investors will be rewarded by monitoring companies and managements closely. To that end, we hope this publication is a useful resource.

BNP Paribas European High Yield Research Team