Abengoa thermal solar plant is seen near Seville, Spain. Abengoa is being removed from Europe’s high-yield credit-default swaps index because it’s become too distressed, raising concern that the benchmark may provide less protection against losses for junk bond investors.

Bloomberg
London


Abengoa is being removed from Europe’s high-yield credit-default swaps index because it’s become too distressed, raising concern that the benchmark may provide less protection against losses for junk bond investors.
The Spanish renewable energy company will exit the Markit iTraxx Crossover Index of non-investment-grade companies on Monday because the cost of insuring its debt is too high. New series of credit-default swap benchmarks are created every six months when companies are added or dropped depending on their ratings, cost of protection and ease of trading.
Markit’s rules for inclusion in the $17bn high-yield index are meant to reflect Europe’s junk bond market. Abengoa, which has about €3.8bn ($4.3bn) of bonds outstanding according to data compiled by Bloomberg, remains among the largest speculative-grade bond issuers in Europe and the most traded credit-default swaps in the measure even though it’s one of the world’s most distressed borrowers.
“If you’re an investor, you want to be able to put on a proper hedge for your bond portfolio so you need an index that reflects the market,” said Dan Friedman, head of European high- yield, loans and distressed credit trading at Barclays.
 “The swaps index should be very closely tied to what the bond market looks like. Given the amount of notional bonds outstanding, keeping Abengoa in the index would make more sense than removing it.”
Seven of 75 companies are being replaced in 24th series of the Markit iTraxx Crossover Index, mostly because their credit quality improved rather than deteriorated. Swiss chemical maker Clariant, Eileme 2, Smurfit Kappa Acquisitions, TVN Finance Corp III and New Look Bondco are among those leaving. New Look Senior Issuer, Renault, Matterhorn Telecom Holding, International Game Technology, HeidelbergCement, Ephios Holdco and Air France- KLM will join.
Like Abengoa, Norwegian papermaker Norske Skogindustrier is being replaced because its swaps cost more than the index limit of 50 percentage points upfront. Sellers of default protection typically demand payment in advance when they perceive an imminent risk of default.
Markit decides the composition of the gauges it administers according to trade volumes published by the Depository Trust & Clearing Corp, as well as cost of swaps.
Abengoa was the fifth most-traded company in the Crossover Index in the six-month review period that ended August 28, with swaps covering a weekly average of $191mn, according to DTCC.
“Regardless of how highly traded the names are, the rules are there to stop the Crossover from having deeply distressed names,” said Mahesh Bhimalingam, Head of European credit strategy at BNP Paribas in London. “Isolux was close to the limit but sneaked through this time. It will be interesting to see if that name stays in next time.”
Grupo Isolux Corsan, another stressed Spanish engineering and construction company, will remain in the index because its swaps trade below the limit. Those contracts are quoted at 43% upfront and signal an 82% probability of default, according to data provider CMA.
Abengoa’s swaps are quoted at 69% upfront, meaning it costs €6.9mn in advance to insure 10mn euros of bonds for five years. That’s in addition to €500,000 annually and imply a 95% likelihood of default, CMA prices show. Swaps on Norske Skog cost 73% upfront, indicating a 92% chance of default.
“Often when a spread is this wide the contracts can become illiquid, but that isn’t true in the case of Abengoa,” said Michael Hampden-Turner, a CDS specialist on the credit trading desk at HSBC Holdings in London. “Portfolio hedgers lose some hedging accuracy with Abengoa leaving the index.”