The laissez faire school of finance has always orientated towards the notion that capital market funding is preferable to bank financing. Why? Because it’s only by taking your business to the open market that a borrower’s situation can be properly scrutinised and a fair price arrived at.
But, of course, some capital markets are more developed, sophisticated and disintermediated than others. In the US, for example, funding by way of the capital market is common practice even for small and medium-sized corporations. Unsecured household borrowers are even heading to P2P market-based lending solutions. In Europe, however, the private sector — especially the SME sector — has always tended to fund through bank loans. Read more
With apologies for the angelic imagery, here’s BNP Paribas on Wednesday (our emphasis):
In our analysis, six EM sovereigns are at risk of becoming fallen angels this year or next. Three of these we consider ‘high risk’. As much as USD 259bn of sovereign and corporate bonds is at high risk of being cast down into speculative grade perdition. This accounts for 9% of all EM bonds outstanding (USD 2.87trn).
… it is little surprise that the peak of credit quality for EM appears to be over. After having hit the BBBthreshold in 2013 and improving another 1/6th of a notch over2013 (Figure 2), the credit quality of the EM benchmark has begun to slide downward. Already it has lost 1/6th of a notch and we forecast the index to slide another half notch by the year end.
Actually, the way Creditsights frames the question about credit issuance is “can it continue?” which points to their answer: probably, even if not at peak levels.
Speaking of which, if you have an investment grade credit rating, you must have been enjoying the party.
USD fixed-rate investment grade corporate issuance totaled $265 bn in the first quarter, which was a $75 bn increase over 4Q13 numbers and $30 bn greater than the amount seen in the first quarter of 2013. The 1Q14 tally only trails two prior periods: the $285 bn in 1Q09, when issuance was boosted by the TLGP program, and the $278 bn seen in 1Q12.
Gary Jenkins from Swordfish Research is having a moment; but it’s an interesting moment. On Monday he wrote:
“A while back I said that everything was now a credit and at the time that seemed a fair appraisal of the situation… However the market moves quickly and it is probably fair to say that right now everything is a rate product.*”
(The Co-Op bank, he says in the footnote, being the exception that proves the rule.) Read more
Here’s Deutsche’s Jim Reid on junk bonds — where both defaults and yields are now far lower than they were in the 1980s — in Thursday’s Authur’s note:
We’re going to need a new name for junk bonds. They’re yielding less than 5 per cent for the first time ever (h/t to our own Tracy Alloway):
The 5% yield barrier has proved no match for this Federal Reserve-fueled junk-bond market, which last night reached yet another all-time record-low average yield-to-worst of 4.97%, according to the Barclays US High Yield Index. It marked a new level of market capitulation to central-bank forces as it’s the first time the index has dipped below 5% in its 30-year history (before January the market had never even fallen below 6%). The average price of 107.31 cents on the dollar also marks a record high.
The big leveraged buy-out groups of the credit boom have gained renewed access to funds as the junk bond market has rallied and buyers have flocked to the highest-yielding assets, says the FT. Energy Future Holdings, Realogy and Caesars Entertainment, formerly Harrah’s, are among those groups controlled by private equity funds that have sold junk bonds in recent weeks as they seek to manage their overburdened balance sheets. The capital markets have reopened to highly indebted companies after central banks moved to keep official rates low and sentiment in US and European markets has improved. The renewed appetite for risk has given a partial reprieve to some private equity-owned companies from looming debt repayments.
Companies sold record amounts of junk bonds globally last week in the latest sign of relentless demand for low-rated corporate debt this year, says the FT. Even companies in Europe where the junk bond market essentially had shut down just a few months ago are finding buyers. Issuance totalled a record $19.6bn last week, including a sizeable chunk of debt that European companies sold in the US, according to Dealogic, the data tracker. Schaeffler, the private German precision engineering company, was among the recent issuers, debuting in the capital markets with the biggest euro junk bond in nearly six months as well as debt denominated in US dollars. US funds that buy junk bonds have taken in net cash of $9.4bn this year while similar European funds have had net inflows of $81m.
Banks in Europe are turning to the US junk bond market to offload European bridge loans before the end of the year, the FT says. The overhang of “hung” bridge loans requiring replacement with bonds or loans may see banks forced to swallow losses on several high-profile deals. Leveraged loan syndications in Europe have slowed significantly since the summer, despite discounts being offered by banks keen to clear the deals this year, according to investors. A tentative recovery in the European high-yield bond market has also been derailed recently, spurring some companies to head to the more vibrant US market.
Or: do wide high yield spreads over US Treasuries predict a recession?
We ask because this is an interpretation we’ve seen a fair bit in the media over the last few weeks. Read more
Global markets for raising capital mostly shut down in August, especially for smaller and riskier companies, amid a surge in volatility and a pullback in investor flows, the FT reports. August is normally a slow summer month. But even on those terms, markets saw a dramatic reversal of attractive financing conditions for even low-rated corporate issuers, sparked by worries that the burden of sovereign debt in the US and Europe is going to make it harder to rescue a slowing global economy. The high-yield, or junk bond, market had the slowest August globally since at least 1995, according to Dealogic, when it began tracking the market. The small to midsized companies that typically issue equity also had a hard time, especially in the US, which had been seeing healthy deal flow earlier this year as strong debuts for the likes of LinkedIn, the social networking site, sparked interest in start-ups. “When people are in a risk-off mode, these are the deals that become hardest to do,” said Craig Orchant, partner at EA Markets, a capital markets advisory. August was the first month with no euro-denominated, investment-grade corporate bond sales since the European common currency was introduced in 1999.
The market for junk bonds is enduring its worst rout since the depths of the financial crisis, says the WSJ. Demand for high-yield bonds sold by the riskiest US companies has nearly dried up, and new junk-bond offerings in August were at their lowest level since December 2008. Retail investors have been withdrawing record amounts from high-yield mutual funds, forcing those funds to dump bonds in order to raise cash, driving prices even lower. Returns on bonds rated below investment grade fell to -5.1 per cent in August, the worst monthly performance since November 2008, according to the Barclays Capital US High Yield Index. The performance of junk bonds highlights the disparity in sentiment between the bond markets and equity markets, where optimism about possible further quantitative easing measures has bouyed stock markets.
Junk bonds have entered a rough patch, writes the FT. For more than six weeks, the interest rate premiums over benchmark US debt demanded by investors in these risky corporate bonds have increased. That rise has fully eroded the year’s gains in prices, which move inversely to yields. It looks as if, after an impressive bull run, investors’ once insatiable demand for higher-yielding corporate bonds, which led to record new bond sales in May, has finally ended. Indeed, investors have been withdrawing money in droves. The Greek debt crisis and sparring in Washington over the government debt ceiling has contributed to the sell-off. Mutual and exchange trade funds that buy high-yield or junk bonds, which are defined as debt with credit ratings below investment grade, last week saw net outflows of $1.6bn, the biggest weekly withdrawal by investors for these funds in more than a year, according to Lipper.
An uptick in mergers and acquisition activity is set to boost issuance in the US leveraged finance market as investors in Europe strike a note of caution on market dynamics there, according to the FT. Leveraged loan and junk bond issuance has been strong in the US this year, driven by companies’ efforts to refinance debt borrowed during the credit boom of the past decade. Bankers and market experts, however, are now pointing to a growing pipeline of deals related to M&A. The need for new money for loans and bonds to finance M&A deals, rather than refinance existing debt, could help to ease what has been a cash glut in both markets this year and reduce the instance of controversial financing structures, which have returned in the rally.
Bloomberg Businessweek has an update on the latest refinancing efforts of Energy Future, previously called TXU and once known as The Biggest Leveraged Buyout of All Time.
Bought for $43bn by private equity groups KKR and TPG in 2007, the company’s revenues nosedived along with the price of natural gas and it is now trying to extend the maturity of its loans coming due this year — and will pay a hefty price for the privilege: Read more
Here’s an interesting Wednesday story from the Financial Times’ Aline van Duyn.
It concerns growing demand for a synthetic product — this time linked to junk, or high-yield, bonds. The market size of the product (which is tranched and linked to Markit’s CDX index) is still relatively small. But demand for actual junk bonds has been strong recently — with average junk prices even hitting par value during 2010. Read more
Demand is growing for “synthetic” financial instruments that enable investors to take positions in the junk bond market without owning the underlying securities, the FT reports. The instruments, created by using credit derivatives on junk bond or high-yield indices, bear a resemblance to transactions linked to US mortgages that proliferated before the financial crisis. However, synthetic junk bonds have been in the market before. Similar investments blew up after corporate defaults unexpectedly soared when the telecoms bubble burst in the early 2000s. Dealers also argue that banks’ pre-crisis off-balance- sheet investment vehicles are now defunct, limiting the investor base.
Demand is growing for “synthetic” financial instruments that enable investors to take positions in the US junk bond market without owning the underlying securities, reports the FT. The instruments, created by using credit derivatives on junk bond or high-yield indices, resemble transactions linked to US mortgages that proliferated before the financial crisis. Exposure to such instruments proved toxic for the banks and investors that bought them, causing huge losses, and substantial profits for hedge funds that sold them. Now, hedge funds are buying the riskiest parts of instruments linked to bonds, in a trend indicating that investors believe US economic recovery will lead to lower corporate defaults.
The SEC is investigating whether high-yield muni bond mutual funds are overstating the value of illiquid, high-risk holdings, the WSJ says. Sources said that the Commission was concerned that investors in the fund could have been misled about the real value of the their investments. Mutual funds in the sector have been hit by investor withdrawals as the wider muni market falls, selling off high-yield muni debt to raise cash. Around $24.7bn of net outflows have been recorded since late November. Junk muni bonds are a small part of the overall $3,000bn market, totalling no more than $54bn in value. Nevertheless, the SEC is looking at so-called ‘tobacco’ and ‘dirt’ bonds which can go for years without changing hands, sources said.
Courtesy of Thomson Reuters:
The value of worldwide mergers and acquisitions totals $309.6 billion through year-to-date 2011, a 69% increase over last year at this time and the strongest start for M&A since 2000, when the opening weeks of the year saw $554.2 billion in deal activity. Financials, materials and energy & power M&A account for 60% of this year’s total, compared to 2000 when media, telecommunications and healthcare M&A drove 70% of announced activity.
Moody’s has released its full-year 2010 default rates for high yield bonds and loans, and unsurprisingly the improvement over 2009 was impressive:
The global speculative-grade default rate finished 2010 at 3.1%, a level very close to our one year ago prediction of 3.3%. The global rate stood at a much higher level of 13.1% in 2009 and 4.4% at the end of 2008. In the U.S., the speculative-grade default rate ended at 3.3% in 2010, down from 14.1% in 2009 and 4.9% in 2008. In Europe, the comparable rate closed at 1.9% in 2010, also down from 2009’s 11.3% and 2008’s 2.1%. …
Courtesy of Reuters, a new milestone for junk debt issuance:
The volume of global high yield corporate debt topped $300 billion this week, shattering the all-time annual record for high yield bonds set in 2006 ($185.0 billion). Bolstered by triple-digit growth in the industrials and energy & power sectors, issuance during the fourth quarter of 2010 totals $90.4 billion from 186 deals, the biggest quarter, by proceeds raised and number of deals, since records began in 1985.
If it’s good enough for the Fed, then it’s good enough for legions of investors…
That would seem to be the message, at least, from one of the many interesting aspects of this week’s Federal Reserve data bonanza. Read more
US banks flooded the Federal Reserve with billions of dollars in junk bonds and other low-grade collateral in exchange for liquidity during the financial crisis, the FT reports, citing newly-released Fed data. More than 36% of the cumulative collateral pledged to the US central bank in return for overnight funding under the Primary Dealer Credit Facility was equities or sub-investment grade bonds. A further 17% was unrated credit or loans, according to an FT analysis of Fed data. Only 1% of the collateral was Treasury bonds, normally used in transactions between banks and monetary authorities. The Fed created the PDCF in March 2008 after the collapse of Bear Stearns to ease banks’ liquidity problems.
Retail investors in the US have sharply increased their direct buying of junk bonds in the third quarter, highlighting a “yield chasing” trend that is worrying regulators, reports the FT. Finra, which regulates US securities firms, expressed concern about risks in this part of the corporate bond market, citing data showing a big leap in the ratio of buying relative to selling of junk bonds by retail investors. Separately, the FT examines two opposing views on whether the corporate bond market in general, including the junk sector, are becoming ‘too hot’.
Retail investors in the US have sharply increased their direct buying of junk bonds in the third quarter of the year, providing evidence of a trend of “yield chasing” that is worrying regulators, reports the FT. Finra, which regulates US securities firms, said the trend was a concern given the risks involved in this part of the corporate bond market. Corporate bond trading activity analysed by Finra shows that the ratio of buying relative to selling of junk bonds by retail investors has jumped in the last quarter. Junk bonds, also called high-yield bonds, are sold by companies with ratings below investment grade, a category which has a higher risk of default.
Strong investor demand for junk bonds has pushed the average price on such corporate debt to its highest level since June 2007, the FT reports. The BofA Merrill Lynch index used to track the market pushed back above 100 last week, a level last seen at the height of the credit boom. Junk issuance this year already outweighs the total seen throughout 2009. Then again, risk has returned too, the WSJ adds, because investors aren’t checking if indentures on the bonds protect them from company actions or changes in control. But even if investor rights are in danger, demand will go on — there’s just too little supply of debt elsewhere.
Strong investor demand for junk bonds has pushed the average price on such sub-investment grade corporate debt to its highest since the mid-2007 peak of the credit boom, reports the FT. The Bank of America Merrill Lynch index used by many investors to track the junk bond market rose last week above 100 for the first time since the start of the credit crunch. The prices of many such bonds collapsed amid the crisis as default rates soared. But their recent rise above 100 assumes that, on average, bonds will be repaid in full.
In common with many investors, pension funds have a problem, which can be summed up in the following two graphics from UBS:
We’ve been keeping a watchful eye on this year’s junk debt bubble rally, if only because its implications could stretch well into the future.
It remains unclear whether investors have made a wise decision by going further out on the yield curve and snapping up speculative-grade bonds in near-record amounts. (An updated estimate from Reuters (HT Lex) in early September puts global high yield debt issuance at $177bn this year.) Read more