We always recap the happenings within the primary, or new issue, market several paragraphs down in this monthly memo, though we haven’t featured it in the prologue in a while despite record setting volumes near every month this year. So, here it goes. Long overdue. Let’s open with some pictures to set the stage:

Borrowing Binge...YTD High Yield Issuance Dwarfs Prior Years

Source: Credit Suisse

Cheap Capital Incentivizing Refinancing as Well as M&A/LBOs

Source: LCD

The quantum of debt issued year-to-date by U.S. high yield borrowers is unmatched over the same period each year for the past two credit cycles. Some $251 billion of debt has been syndicated at a monthly pace of +/-$50 billion, with each month’s volume representing the highest-total EVER for that particular calendar month. Indeed, “record issuance for the month of [insert month]” has been a constant in the subject line of emails from high yield strategists every month this year. Ultra-low borrowing costs have clearly incentivized both bellwether as well as first-time borrowers (true first-timers as well as borrowers that previously accessed their leverage exclusively in the loan market) to pay the call premium and refinance higher cost debt. Though regular way refinancings result in zero net debt creation, incremental duration is created, and at record low all-in yields no less. Strategic M&A and sponsor LBO financing activity has also picked up in recent months, accounting for just under 30% of issuance in April and May. Just this past week was the announcement of the Medline deal. The return of mega-cap, private equity consortium led acquisitions (reminiscent of the 2006-2007 era mega-buyouts) hints at further debt issuance to come.

The new issue syndication process can be rather monotonous, particularly for recurring borrowers where the institutional investor community already has intimate familiarity with the fundamentals of the credit (less so with first-time or higher risk / more storied credit underwriting). Syndicate desks typically announce a deal by distributing an offering document, summary terms and an opening salvo termed the “initial price talk” or “IPT.” That offer price, typically in the form of a coupon for a deal that will syndicate at par, anchors the market’s expectation for the ultimate clearing price (yield) of the deal. The price is informed by observable yields in the marketplace for comparable risk (whether it be other bonds within the borrowers’ capital structure or the bonds of comparable borrowers) and in certain instances will have been vetted with key constituents ahead of time. So what do these IPTs look like in a marketplace with such little dispersion in observable yields? Well, they tend to look a lot alike. Indeed, the “low-4s” (i.e. low-4% yield) IPT has seemingly become the default anchor for deals syndicated in this +/-4% yielding high yield marketplace. Approximately 30% of the deals syndicated in May had an initial or final price with a low-4% yield and almost half of the deals thus far in June have an initial or final price in the low-4s.

We highlighted this feature of the current marketplace in recent memos, where bonds have become less and less distinguishable on price (yield / spread) alone. This is true both among the stock of existing bonds as well as the flow of newly minted paper. Interestingly, while we tend to think about a credit picker’s market as one characterized by elevated dispersion, it is during times when bonds become indistinguishable that credit pickers (active managers) can construct portfolios with highly distinguishable prospective return patterns.

Market Performance

High yield bonds returned a bit less than their coupon in May, compounding lackluster year-to-date returns by an incremental +0.30% to +2.25%. Traders characterized the marketplace as trading very “technical” with seemingly structural demand for (relative) yield and heightened animal spirits suppressed by outflows and elevated issuance. The net effect was a range-bound grind for most of the month.

CCC-rated and distressed securities outperformed lower yielding and (more) negatively convex higher quality bonds yet again in May. The degree of outperformance has narrowed, however, as absolute valuations across the quality spectrum have compressed leaving less and less room to run. Despite all this “good” getting pulled forward into returns, the fundamental tailwinds to the economy and capital markets remain uninterrupted.

Source: Bloomberg, Barclays

Though valuations and returns patterns have generally become less distinguishable (per our comments above), this past month saw some marginal out- and under-performance across sectors. Specifically, Energy-related credits, particularly those most operationally (and financially) levered to a recovery in oil and gas prices, extended their outsized gains in May with the reflation in commodity prices. On the other end of the spectrum, the bellwether capital structures of Endo International and Bausch Health in the Pharmaceutical sector independently repriced by several points given the flare-up of discrete risk factors (namely, opioid litigation with respect to Endo and an adverse business reorganization event with respect to Bausch).

Source: Bloomberg, Barclays

Market Technicals

High yield bond funds suffered the largest flight of capital for the year this past month with outflows totaling -$3.9 billion. All of the funds were redeemed from actively managed mutual funds as ETFs benefited from marginal net inflows. The reason is probably less important than the reaction and the reaction was rather muted itself. Indeed, while the exodus may have tempered the bid in the market for bonds on the margin, it did little to incite much, if any, price volatility.

Relatively Large Outflows in May Still Did Little to Disturb Range-Bound Prices

Source: Credit Suisse, EPFR

We put the spotlight on the primary market in the prologue above, but to provide some specific statistics for the month of May:

• $49 billion of USD-denominated high yield bonds were issued during the month
• This was a record issuance for the month of May

Fundamental Trends

Still all quiet on the corporate default front, at least among sub-investment grade corporate borrowers. Including distressed exchanges, a total of three high yield borrowers have defaulted on their bonds this year (one each month for the past three months following two months of absolutely zero default activity). Needless to say, the opportunity set of stressed and distressed credit situations is very thin, particularly as some of the largest restructurings from last year have concluded or are approaching an end to their workouts. That being said, the funnel of emerging opportunities isn’t completely dry as discrete risk factors flare-up and impact certain capital structures. One example are the bonds of Endo International (ENDP) that have fallen in price by as much as -22pts since March with the unsecured bonds now trading in the mid-60s. May prove fertile ground for new investment opportunities.

As we observed in recent months, the pandemic-induced default cycle appears to have reached its end as capital is plentiful, lender behavior is risk seeking, and convexity and high yields are scarce. We began tracking the following market statistics in recent months and will continue to present them here until the data becomes less…well…anomalous:

• 1.4% of the bonds in the $1.5 trillion high yield marketplace trade at a price below $90 (this in a market value basis)
• 0.6% trade at a price below $80
• Just 14 CUSIPs…that’s right, CUSIPs…trade below $70
• Only three CUSIPs trade below $50

Again, rightly or wrongly, default risk is unambiguously (objectively) not priced into our market.

Default Log Month Five, Still Very Few High Yield Corporate Defaults in 2021

Source: Credit Suisse