The downgrade had been widely anticipated, so the impact on the company’s bonds has been minimal. However, Telecom Italia is one of the largest bond issuers in Europe and following the downgrade will become the largest high yield issuer, making up more than 5% of the BofA Merrill Lynch Euro high yield index and 1.5% of the global high yield index.
Given the size of the issuer, there is likely to be some forced selling, particularly from investment grade index trackers / Exchange Traded Funds. However, with sentiment improving in the eurozone, we expect domestic investors to retain their holdings, while demand from active investment grade and high yield investors is likely to remain positive, given the positive flows into these asset classes.
Telecom Italia’s troubles have been well flagged, with EBITDA (earnings before interest, tax, depreciation and amortisation) down 10.1% (year-on-year as at Q3 2013), stemming from an intensely competitive Italian mobile market, regulatory headwinds and a weak macroeconomic picture. This situation has been further exacerbated by governance issues, management team failures, and a gradual increase in leverage.
Our previously negative fundamental view has somewhat moderated when assessing Telecom Italia as a high yield credit. We had been underweight in investment grade portfolios (favouring shorter maturity bonds), but have now moved to a more neutral stance, given the relative strength of Telecom Italia’s balance sheet and liquidity versus high yield peers.
Note: For our US and European high yield funds, we use a 2% constrained index, which caps the maximum issuer weight at 2% in order to minimise both the impacts of large issuers on index rebalancing and concentration risk.