European peripheral companies have continued piling on debt without cutting their already high leverage levels making them riskier than many investors realise, says Euro Stars AAA-rated manager Victor Verberk.
Firms such as Italy's telecom giant, Telecom Italia, have continued to issue new bonds despite paying higher costs of borrowing and with riskier outlooks than debt from healthier economies, wrote Verberk in a quarterly note to investors.
'We see insufficient proof that peripheral companies are determined to reduce leverage. On the contrary, since credit markets have reopened for them some companies are even increasing their debt,' said Verberk, who runs the Robeco Euro Credit Bonds fund.
'Peripheral spreads are still wider than core European spreads but downgrade risks are higher as well. In addition, spread per turn of leverage looks much more inline because peripheral credits have a higher leverage. All in all, we see no value in investment grade peripheral spreads and hardly any in high yield peripheral spreads.'
Investor concern has increased particularly in Italy and France where deficit-reducing reforms and political changes have been less stable than expected.
'Italy is politically very unstable and we see this as a risk for the trend of normalisation within the euro area,' Verbeck said, who was underweight both Spanish and Italian credit in the first quarter of this year and has sold out of some Italian names ahead of the country's election.
'The market has continued to discount tail risks. We doubt if that is justified as political instability and potential social unrest could easily derail the process.'
Spain, compared to Italy, is considered to be a forerunner in term of labour market reforms.There is, however, 'still a serious chance of a downgrade into high yield for Spain. The country is rated Baa3, with a negative outlook,' he wrote.
'This downgrade risk was a hot topic in 2012 but the theme has faded lately. We warn that the risk has definitely not gone away and could catch the markets by surprise.'
Names added to the Robeco Euro Credit Bonds fund in the past quarter include UK company Ford Motor Credit, Spanish energy utility company Iberdrola, French food company Danone and the Swiss insurance firm, Zurich.
In the last three years, Verberk returned 19.9%. The average return in the European corporate bond sector was 15.2%.