As Credit Markets Rebound, Neediest Borrowers Are Left Behind
The $1.2 trillion U.S. junk-bond market has staged a marked recovery in recent days. But pull back the curtain and it’s clear not all borrowers are reaping the benefits equally.
For many of the riskiest credits, the situation remains as dire as ever, leaving them with little chance to access the financing they desperately need -- at least, not anytime soon. Risk premiums on bonds rated CCC remain near the widest since 2009 relative to securities a few notches higher in the B and BB buckets. The Federal Reserve’s announcement Thursday that it will start buying debt recently downgraded to the highest junk tier could ultimately exacerbate the divergence, according to analysts, even as the broader market rallies.
The growing disparity between speculative-grade issuers may signal that a wave of restructurings among the most leveraged companies is largely unavoidable, even if the global economy is able to turn the corner in the coming months. Barclays Plc said last week it expects high-yield defaults to reach 9% to 10% in 2020, while Goldman Sachs Group Inc.’s forecast was even more bleak, predicting a trailing 12-month average of 13% later this year.
“In periods of economic uncertainty or market uncertainty, as well as expectations of earnings declines, there is generally going to be a flight to quality overall because that uncertainty is magnified the further you go down the risk spectrum,” said Steven Oh, global head of credit and fixed-income at PineBridge Investments.
Oh said he’s underweight CCC rated debt and is avoiding adding energy-sector risk in particular.
Of all the measures used to gauge the strength of U.S. credit, the gap between investment-grade and high-yield risk premiums is among the most closely followed. U.S. junk bonds on average pay 5.52 percentage points more than investment-grade notes, down from a high of 7.27 percentage points late last month, according to data compiled by Bloomberg.
But some market watchers now say the metric is concealing dangers lurking beneath the surface. Bonds in the CCC tier are trading at an average spread of 16.4 percentage points relative to Treasuries. Not only that, but the gap relative to B rated notes has ballooned to 8.62 percentage points, barely off last month’s highs and near the widest since the depths of the financial crisis.
Just as concerning, the spread between B rated and BB rated securities -- at 2.44 percentage points -- remains the widest since 2016.
As a consequence, the primary market has remained virtually shut for all but the highest-rated, most liquid speculative-grade issuers. BB rated Yum! Brands Inc. last week was the first company to raise funds in nearly a month when it sold $600 million of debt.
Since then, companies including similarly-rated Restaurant Brands International Inc. and Wynn Resorts Ltd. have priced deals, while split-rated Ferrellgas has been the only credit with at least one CCC rating to tap the market.
To make matters worse, investment-grade companies directly impacted by the Covid-19 outbreak such as Carnival Corp. and Nordstrom Inc. are turning to junk-bond buyers for financing. Even when transactions aren’t being conducted off of bank high-yield desks, funds dedicated to the asset class are increasingly buying blue-chip deals amid attractive rates and a record spurt of supply, limiting market access for lower-rated issuers.
Still, the biggest rally in high-yield debt in over two decades Thursday after the Fed’s historic move to begin buying some speculative-grade corporate debt may be just the spark needed to unleash riskier deals.
Bankers are talking to large corporations that have been waiting for the market to improve, according to people familiar with the matter. They’re also engaged with private equity firms about options for their portfolio companies, said the people, who asked not to be identified because the discussions are private.
For their part, analysts at Barclays led by Bradley Rogoff called Thursday’s market rally “extreme,” saying in a note to clients that the additional Fed measures will provide strong support to the potentially hundreds of billions of dollars worth of bonds that are expected to fall into the BB tier in the coming months, but that for the rest of high yield, the stimulus “disappoints.”
The Fed’s decision may ultimately prompt money mangers who get crowded out of the BB space to reach for riskier credits, narrowing the yield gap, according to John McClain, a portfolio manager for Diamond Hill Capital Management.
Others aren’t so sure.
“Your truly distressed credits may benefit at the margin as capital continues to flood into high yield, but the survival prospects are basically unchanged,” said Noel Hebert, director of credit research at Bloomberg Intelligence. “The economy is still deteriorating and the Fed’s program, while a temporary balm for asset prices, isn’t altering demand for oil or the urge to hit the mall.”