New York: After weathering the stock-market turmoil all week, junk bonds have started to crack.
Bonds of energy producers, health care companies and telecommunications providers that finance themselves with speculative-grade debt tumbled for a second day on Friday. That pushed up borrowing costs for companies that have been trying to fix debt-laden balance sheets, and it’s causing some companies to sweeten terms on new debt they’re selling.
“We’re really flipping from a positive economic scenario to a negative economic scenario,” said Ben Emons, chief economist and head of credit portfolio management at Intellectus Partners LLC in Los Angeles. “That takes its toll immediately — not only in equities, but it starts to become an issue in high-yield.”
The biggest exchange-traded fund that buys the debt dropped to the lowest level since November 2016, after clocking its worst day in more than a year on Thursday. Further adding to the pain was oil’s worst week in almost a year, with crude dropping below $60 a barrel for the first time this year. Investors pulled money from high-yield bond funds for the seventh week in nine.
The market weakness is driving up yields for some of the biggest junk-rated borrowers, including hospital chain Community Health Systems Inc., energy company California Resources Corp and rural phone company Frontier Communications Corp.
The cost to protect against losses on junk bonds rose Friday to its highest level since December 2016. High-yield debt markets in Europe and Asia slumped.
Broader sell-off
Fund managers aren’t yet panicking. After all, the extra yield demanded to hold US junk bonds instead of Treasuries — at 3.46 percentage points on Thursday for a benchmark Bloomberg Barclays index — is still well below the average of the past five years. But some were concerned that continued pressure could trigger a broader sell-off.
“There’s a point at which you can’t avoid the pressure in equity markets and it starts to bleed through to high-yield” bonds, said Noel Hebert, an analyst at Bloomberg Intelligence.
The bleeding was evident Friday, when Flexi-Van Leasing Inc sold $300 million (Dh1.1 billion) of second-lien notes at a significant discount with strengthened protections for investors, according to a person with knowledge of the matter, who asked not to be identified as the details are not public. Borrowing less than the face value of the debt, known as original-issue discount, reduces proceeds for the company while increasing the yield for investors.
Apex Tool Group LLC, a manufacturer of hand and power tools, had to offer investors a 9.001 per cent coupon — above initial talk in the range of 8.75 per cent to 9 per cent — to sell its $325 million issue, according to a separate person with knowledge of the transaction, who also requested anonymity discussing a private matter. The company is also marketing a loan sale, with commitments due Monday.
Volatility shaken
US stocks ended their worst week in two years on a positive note, after sell-offs continued in Asian and European markets.
Though volatility has been shaken from its prolonged slumber, it’s too soon to say whether the current shock will lead to tighter availability of credit and a subsequent increase in credit losses, Bank of America Corp strategists led by Oleg Melentyev said in a report Friday. Since relative valuations haven’t changed much, the strategists recommend buying the dip in CCC bonds as well as spread curve flattening trades in BB levels.
“It is too early to be underweight the credit risk,” the strategists said. “The relatively stable performance in high yield in the face of extreme moves in equities falls in line with our expectations.”
Given outflows from high-yield and inflows into investment-grade bonds, there’s still a demand for spread in credit, said Greg Peters, a senior investment officer at PGIM Fixed Income, which oversees almost $700 billion.
“Is high yield in aggregate a screaming buy? Absolutely not. But are there pockets of value? Absolutely,” Peters said in an interview with Bloomberg Television’s Jonathan Ferro on Friday. “The one area that has value in our view are the CCC’s.”
The weakness in junk started in the most actively traded instruments, mainly ETFs and credit-default swaps, which insure investors against losses if an issuer fails to pay. Investors have been snapping up those contracts all week, pushing the cost to the highest since December 2016.
“It’s all ETF-driven — it doesn’t feel like real money is selling, but it’s not buying either,” John McClain, a portfolio manager who helps oversee $21 billion of assets at Diamond Hill Investment Group, said Thursday. “You could get into a short-term liquidity crunch and could see some disorder in our market. But until that happens, it’s not panic time.”
By Friday, however, more sales of underlying bonds were starting to populate the bond-price reporting system known as Trace:
Investors have proved willing to take on risk in other credit markets. US leveraged loans are staying resilient to the volatility and holding onto their gains for the year. And bank loan mutual funds received $612 million of weekly inflows, the third consecutive week of inflows and largest since March, according to data compiled by Lipper.
Matt Kennedy, a high-yield manager at Angel Oak Capital Advisors, said he’ll be looking to buy the dip on some bonds.
“Guys have been coming in showing bids for a variety of names despite the move,” he said Thursday. “It doesn’t feel panicky.”
