Riskiest Junk Borrowers Imperiled as Borrowing Costs Climb

Buyers of the riskiest part of the US corporate bond market demand the highest yields in nearly two years, signaling the time may be coming to an end for wide-open funding to the neediest borrowers.

CCC or lower rated company bonds in the US are yielding 5.6% points over the highest rated junk notes. According to index data compiled by Bank of America Corp. Companies, company bonds jumped from 3.9% points, a seven-year low this past June. These bonds, which are extremely vulnerable to default, sold $10.2 billion of bonds during the quarter, less than half the quarterly average over the past two years.

Following six years of easy money policies set by the Federal Reserve that opened debt markets to companies with the least credit worthiness, investors have become increasingly more discriminating as the prospect of interest rates boosts the likelihood of defaults.

In a statement from Thomas Byrne, director of fixed income at Wealth Strategies and Management LLC, cracks at the bottom are starting to develop. He added that people are starting to move up in credit quality because no one wants to be the last person standing in a burning room.

Regarding bonds in the lowest part of the S&P’s junk tier, a loss of 0.6% was reported in November. These bonds are also poised for declines in a third month, as shown by data compiled by the Bank of America. If this happens, it would securities’ longest running losing streak since the 2008 financial crisis.

The number of high risk and high yield investors expecting credit quality of junk rated borrowers to weaken jumped 31% this month, up from September’s 26%.

Most respondents also predicted a rise to as high as 4% in the coming year for default rates, making that more than the 2.3% rate that Moody’s Investors Service tracks globally and compares to the 4.7% historical average.

Martin Fridson, money manager at New-York-based Lehmann Livian Fridson Advisors said in a phone interview that at the bottom tier of the market there is vulnerability, in spite of surface conditions appearing constructive. He believes the most critical factor is the potential for price erosion preceding default.

On the riskiest junk bonds, average yields climbed to 10.5%, this after reaching an all-time low in June of 8.7%. Regarding the highest speculative grade tier of BB, investors are now demanding roughly 5% opposed to five months prior at a low of 4.5%.

There is also caution among investors in Europe where the most they demand to hold B-rated Euro notes is almost at the widest level in two years relative to debt that was graded one tier higher.

Henry Craik-White, senior analyst at ECM Asset Management who oversees $8 billion said at the moment, there is definitely a grab for quality.

As shown in data compiled by Bloomberg, the $10.2 billion issuing of dollar-denominated bonds with an S&P CCC rating or below for this quarter compares with an average over three months of $22.5 billion throughout the past two years.

New York-Based analyst Benjamin Garber with Moody’s reported on November 17 that a sustained upturn for high yield credit markets in the coming months is needed in order to boost greater volume of debt issuance within the highest risk rated categories.

At the height of the last credit bubble, bond sales on a global basis by low rated borrowers reached $54 billion within a six-month period that ended July 2007. According to Garber, in 2007 the average price of debt dropped to $0.84.5 on the dollar at the end of December, this after hitting a high of $0.97.4 the prior May. However, prices had dropped to an all-time low of just $0.31.6 by December 2008.

As stated by Fridson, with the default rate being low, it is possible to own the riskiest bonds with impunity but the mistake is that this action ignores what occurred in 2008 when the default rate was exceptionally low.

In a quarter Bloomberg Global Poll conducted last week, nearly 50% of investors, analysts, and traders chose debt securities of one type or another when provided an opportunity to speculate on declines. The majority picked junk bonds and government debt versus assets that also included currencies, stocks, commodities, and real estate.

WSM’s Bynre said that as the Federal Reserve becomes less friendly, opportunities that look attractive begin to shrink. While there are opportunities available in high yield debt, it is vital to separate the good from the bad from the ugly.

All trading carries risk. Views expressed are those of the writers only. Past performance is no guarantee of future results. The opinions expressed in this Site do not constitute investment advice and independent financial advice should be sought where appropriate. This website is free for you to use but we may receive commission from the companies we feature on this site.
HTML Snippets Powered By : XYZScripts.com