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Europe headed for long default cycle: CQS

Europe headed for long default cycle: CQS

Tim Stewart

The end of quantitative easing in Europe will trigger a lengthy and pronounced default cycle within the region, according to credit-focused hedge fund manager CQS.

In his mid-year review, CQS founder and chief executive Michael Hintze said the coming European debt cycle will be significantly worse than the US experience.

The US distressed debt cycle is "very much underway", Mr Hintze said, with default rates now at six-year highs of 5.1 per cent, according to Moody's.

However, the US default wave has thus far been driven by natural resources, he continued – and CQS expects that more than 75 per cent of defaulted debt will come from the energy, metal and mining sectors.

"Contagion has been fairly limited as a function of a benign macro backdrop and accommodative fiscal policies [in the US]," Mr Hintze said.

However, Europe is another matter entirely, he said, noting that for one thing, the broader economy has struggled to grow since 2008-09 and corporate leverage remains at high levels.

"As a result, Europe remains home to many zombie companies which are barely cash flow positive and continue to survive simply because they are on life support, courtesy of [quantitative easing]," Mr Hintze said.

"If and when that stops, we anticipate the overall breadth and length of the European distressed cycle will be significantly more pronounced than the US one."

According to Mr Hintze, the distressed debt market has likely been "lulled into a sense of security" by central bank-administered liquidity.

"That said, tension in the global system has been building for some time, with leverage ticking up as a function of aggressive forward assumptions, valuations and cheap financing," he said.

"Similarly to the 2007-08 burst of the leveraged buyout bubble, if and when liquidity dries up and financing costs increase, we could see companies that are burdened with cheap but inappropriate financing structures looking to restructure.

"This would usher in the next global distressed wave," he said.

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Europe headed for long default cycle: CQS
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