It's a small deal, but Conduent (the business processing outsourcing company being spun off by Xerox) had to raise the interest rate and lower the amount it was borrowing after failing to attract enough buyers.
Compass Point's Charles Peabody says this could be "the canary in the coal mine" for the junk bond market.
What's more, junk bond issuance from the largest three underwriters is down 21% this year, and - while the yield curve has been steepening of late - Peabody is spotting the "infancy stages" of a spread widening trade.
Corporate high-yield funds had $4.1B in outflows in the week ended Nov. 2, according to Lipper. This compares to negligible outflows the previous week, but it's nevertheless four consecutive week of net exits.
Alongside general market weakness the past couple of weeks, the strong rally in high yield has begun to crack, with HYG down about 3% (though still up 5.4% YTD).
Investment-grade bond funds saw outflows of $2.5B last week vs. inflows of $1.7B the week before that.
Thanks in part to stabilizing oil prices, Moody's expects the one-year default rate for speculative-grade corporate debt to ease back to 4.5% by August of next year. The rate is currently 5.7%, and Moody's anticipates it rising to 6.4% by the start of 2017.
"Growth has remained warm enough, along with a rebound in commodity prices and good capital market access, to prevent energy and mining defaults from spreading broadly to speculative-grade companies in other sectors," says Moody's, noting energy companies have not only been able to raise cash with asset and debt sales, but also with equity issuance.
Excepting the post-recession years of 2003 and 2009, high-yield is having its best year on record, says Goldman Sachs, with the magnitude of the spread tightening since the February 11 bottom exceeding the team's expectations.
Said spread tightening is responsible for 51% of the sector's YTD return, while coupon income was good for 31%, and lower rate 18%.
Spreads are currently at 588 basis points - already below Goldman's year-end forecast - so it's likely coupon income will have to be responsible for any returns from here to the end of 2016. The risk to the bank's spread forecast is "strongly skewed" to the upside.
The global default rate for bonds rated below investment-grade rose to 4.7% in July, according to Moody's. That's up from 4.6% in June and compares to the long-term default rate of 4.2%.
The year-to-date tally of default hit 102 after 11 defaults in July - the highest monthly amount since 2009.
Moody's expects the default rate to peak at 5.1% in November, before sliding back to 3.9% by next July. For the U.S., the junk bond default rate was 5.5% at July's end, up from 5.2% in June. It's expected to peak at 6.3% by year-end.
In no surprise, it's the commodity sectors leading the way, with a 10% default rate forecast for metals & mining, and 7.2% for oil & gas issuers over the coming year.
High-yield has had a major rally this year, but investors are cooling their appetite for junky paper, writes Lisa Abramowicz. To wit: U.S. Xpress Enterprises scrapped a $320M offering earlier this week as investors demanded higher rates for the trucking company than it was willing to pay.
It was the first pulled high-yield deal in two months.
Alongside this year's rally is a growing speculative-grade default rate - calculated by Moody's at 5.4% this year vs. 2.1% a year ago. Most of this, of course, can be attributed to the commodity sector, particularly energy.
Things could go beyond oil and gas though. Noting weakening corporate earnings, a team from UBS has boosted its view of the odds of a U.S. recession, which would likely push that default rate even higher, thus making losers of many high-yield investment strategies.
For the month of June, the option-adjusted spread on the BAML High Yield Index widened to 621 bps from 597 bps. In the rally since, it tightened all the way to 542 bps.
By the fair value estimate of Fridson and team, high-yield was overvalued by 166 bps on June 30 - more than the one standard deviation (126 bps) by which they define extreme overvaluation. By July 15, it was a more staggering 245 bps - nearly two standard deviations from fair value.
"They’re out there scrounging through the dumpster looking for yield,” says one strategist. "When you have artificially low rates, you force people to go out and look for things that they normally wouldn’t.”
High-yield mutual funds flew off the shelves this week, with $4.35B in deposits - the largest in more than four months. Looking at individual issues, a $375M bond sold by Valvoline drew $4.5B in orders, allowing the issuer to cut the yield on the offering by as much as 50 basis points.
With $12T of bonds globally offering a negative yield, what's an investor to do?
The iShares High Yield Corporate Bond ETF (NYSEARCA:HYG) saw $291M of inflows during Friday's market panic, according to Bloomberg. That brought weekly inflows for the fund up to a whopping $1.5B - the most this year.
With a Fed hike being completely price out this year (and some now betting on a rate cut), much of that money is from yield-chasing investors, says a BlackRock fixed-income strategist.
The rush of money wasn't able to stem falling junk bond prices over the past couple of sessions. They've rebounded today (HYG is higher by 0.95%), but remain well below last Thursday's closing levels.
Covenant quality tumbled to 4.56 in May from 3.8 the previous month, according to Moody's, which rates on a one-to-five scale, with five being the worst. It was the largest single-month change on record.
Marty Fridson calls the plunge "a discouraging setback," but notes it could be due to the large amount of higher-rated junk issued in May - those high-yield bonds with stronger ratings tend to have easier covenants than the really junky stuff.
More from Fridson: "The long-run trend of covenant quality since the 2011 inception of the Moody’s series has been dismayingly negative. That tendency has been abetted by the investment banks, which compete for underwriting mandates partly on the basis of devising new loopholes."
Jeff Gundlach gets a lot of attention for his calls - many of which prove eerily prescient - but it's only fair to point out the occasional boner.
"Do not buy a junk bond index fund," he said at what proved to be the bottom of the selloff in high yield in January. "You're going to end up selling it at a loss as they get more and more populated with distressed energy and mining issues."
The total return of HYG in the four months since is 12.55%.
It's curious given the low default rate - just 2.83% in 2015 vs. the long-term average of 3.33%. Usually low default rates mean high recovery rates.
Fridson: "This outcome has generated anxiety among high-yield portfolio managers. Has some structural change taken place, they wonder, such that investors should expect lower average recovery rates over the remainder of the present credit cycle than in the past?"
Answering his own question, Fridson says special conditions associated with the energy crash along with one large, non-energy defaulter are behind the low recovery rate. For now, there's no clear evidence that recoveries on a more general basis are lower than they should be.
At the moment, Total Return has just a 2.5% allocation to high-yield, so taking it up to 20% would be quite the move. The junk bond market, says CIO Mark Kiesel, "is as attractive as it's been in four or five years."
Though high-yield has had a monster rally since Feb. 11, it's still at sharply lower levels than one or two years ago, and Bloomberg's Nir Kaissar reminds that though Total Return is a bond fund, it's never shied from taking risks - whether under Bill Gross, or under current management.
Returns of late have suffered - the fund has returned 2.7% annually since Gross left vs. the Barclays Aggregate Bond Index return of 3.7%. AUM has suffered as well - down more than two-thirds from an April 2013 peak of nearly $300B to just $87B today.
Kaissar: "A renaissance for the Total Return Fund has to start with better performance, and one way to juice returns is to pile on more risk."