Market Performance
October high yield bond performance was effectively a microcosm for the back
half of this year: modest accretion to aggregate total return as high quality bonds
outperformed while Energy and CCC-rated credits exhibited acute stress – effectively
sums up the bifurcation in the marketplace since April. Absent, however, were
positive tailwinds from falling interest rates which have been highly accretive to credit
returns this year. High yield bonds on average returned +0.28% in October, bringing
the year-to-date total return for the asset class to +11.71%.
Sponsorship for fundamentally weak credits is virtually non-existent. More frequently
are we observing bonds hit “air pockets” whereby investors go to sell their positions
only to find the marginal clearing price is 20 pts+ lower. Party City is just one of the
latest casualties. After the retailer disclosed poor operating trends, investors moved
to divest their positions only to find no bids in sight. The capital structure re-priced
by nearly 40 pts over a few short days, further evidence that credit is simply no longer
being extended to challenged borrowers.
Latest Casualty: November “Air Pocket” in Party City Bonds
Source: Bloomberg
Meaningful dispersion continues to manifest as these idiosyncratic collapses in the bonds of lower quality borrowers begin to add
up, while borrowers deemed creditworthy are met with excessive demand for the relative “safety” of their debt, no matter the price
(yield). Indeed, the price for “safety” has inflated meaningfully in this market. As a byproduct, the returns on high quality (BBrated)
bonds have outperformed those of lower quality (CCC-rated) bonds this year by over 900 basis points (bps) through mid-
November – unprecedented for a period during which high yield bonds in the aggregate have produced double digit returns.
Source: Bloomberg, Barclays
Credit quality remains the principal vector by which investors are segmenting the market, though this past month we continued
to observe the wholesale disenfranchisement of oil and gas producers and the companies that service them. With the high yield
market in general returning near 12% year-to-date, and several sectors producing upwards of 20% gains, the now deeply negative
returns earned on Energy bonds stands out. Prices of bonds in the sector fell incrementally by -15 to -20 pts across numerous
capital structures during the month – Extraction Oil & Gas, Hi-Crush and Oasis Petroleum, just to name a few. Of note, the
mounting stress among the producers and service providers is just now beginning to transmit to the midstream (pipeline)
operators, which have thus far preserved their access to the capital markets despite ultimately being inextricably linked to the
fundamentals of their shippers.
Source: Bloomberg, Barclays
Market Technicals
Supportive technicals continue to serve as ballast to a marketplace that is undoubtedly averse to taking risk. Capital continued
to flow into the high yield marketplace in October on the order of $3 bn, presumably seeking the relatively “high” yields which
still exist in U.S. credit (and possibly underappreciating the principal being put at risk to try and earn these “high” nominal
yields). ETFs have been the principal beneficiary of the influx of capital, particularly since June, which may represent an area of
vulnerability given the propensity for “renters” to abruptly reverse course and call their capital (i.e. the funds may be less sticky).
Regardless, the high yield market has been the beneficiary of $22.7 bn of capital inflows this year and this has resulted in price
inflation of those bonds which continue to have investor sponsorship (though has done little to dissuade the rationing of credit).
Favorable Demand Technicals Have Inflated High Quality Bond Prices,
Though Have Done Little to Dissuade the Rationing of Credit
Source: Credit Suisse, EPFR
The race to the bottom in all-in yield for those credits deemed by the marketplace to be “high quality” remained in full effect
in October as an incremental 30 deals cleared the primary market with 14 of them carrying a sub-5% coupon. Interestingly, we
observed a dynamic at play in the new issue market whereby the ultra-low cost of capital afforded to borrowers in the European
high yield bond market began to indirectly impact clearing prices domestically. In a series of cross-border financing deals where
issuers marketed bonds denominated in both USD and EUR (Merlin, EG Group, Ziggo), the ultra-low market clearing yield in
the European market compelled issuers to put U.S. high yield bond managers to a decision – accept a lower coupon on the
USD tranche or we will simply finance the entire deal in euros. The U.S. high yield managers acquiesced. Over $18 bn in USDdenominated
bonds were issued in October, following the robust >$30 bn calendar in September and it would appear we are off
to the races once again in November.
Source: Bloomberg, Barclays
Fundamental Trends
Default rates remain low (~2% trailing) as just an incremental two issuers – Murray Energy and EP Energy – defaulted on their
obligations during the month. More attention, however, is starting to be paid to the increasing level of distress in the marketplace,
traditionally a good leading indicator of future defaults given 1) it serves as a gauge of creditworthiness and 2) the reflexive
behavior of the capital markets (stress begets more stress). The analysis below was done by Credit Suisse, though we would take
it one step further and marry the elevation in the distress ratio with the extreme dispersion being expressed in the marketplace.
What we are observing is emerging distress concurrent with extreme segmentation as more and more segments of the market
are being cut off while capital clamors into fewer and fewer cohorts. At a minimum, we believe this dynamic signals a heightened
vulnerability to the entire system.
Rising Idiosyncratic Distress Portends Future Defaults
Source: Credit Suisse