Bonds See Upsurge, But Will It Last?
June 25, 2009
New junk bonds are pricing again, and that alone makes the first half of 2009 a good six months. The second quarter in particular brought a big wave of new issues. Bankers and portfolio managers welcome the uptick and the adjustment in spreads, but few think that pace can be sustained, and the market must still contend with larger macroeconomic factors that are not so positive.
“Certainly the whole correction happened more quickly than we expected,” said Jill Fields, a portfolio manager with Babson Capital Management.
New issues came roaring back in the first half as 111 issuers sold $54.8 billion, according to ThomsonReuters. High-yield new issues totaled $31.4 billion spread among 76 issuers in the first half of 2008. The second quarter was where the real explosion in new issues happened. While the first-quarter U.S. issuance totaled $13.4 billion via 27 deals, 87 issuers priced more than $44 billion in high-yield bonds in the second quarter. In April, more than $9.75 billion in new bonds were priced across 18 deals. May saw things accelerate even further, with 49 issuers bringing $26.5 billion in new notes to the market. May was the most active month for junk bonds since $29.3 billion was issued in November 2006, according to JPMorgan Chase. The pace slowed a bit in June with $18 billion in new bonds issued as of June 23.
“What’s amazing to me is that the capital markets are as active as they are,” said Jeffrey Werbalowsky, senior managing director with Houlihan Lokey. “I’m amazed that people are getting financing … 60 days ago nothing could get priced. I’m amazed that the markets and the psychology of the markets have been so resilient.” He credits the dire need of companies to refinance with the latest boom in new issuance. “There are so many capital structures out there under pressure. People will continue to tap capital markets at whatever price they need to avoid restructuring transactions wherever they can.”
The high-yield new issue market benefited from the perfect storm of inflows from mutual funds looking to put money to work and lots of companies looking for financing. “Investment bankers abhor a vacuum, and the new-issue vacuum was significant,” said Ken Monaghan, a portfolio manager with Rogge Global Partners. “And considering the need out there for paper you knew they were going to fill it. … Clearly there are companies looking to term out their bank debt. On the one side you have supply and you have the investment banking industry pushing to get it out the door.”
However, investors don’t think the pace of the high-yield primary recovery is going to continue like this for the rest of the year. “We’re going to start to fade here. We already have,” said Monaghan. “The pace of the recovery was fast and furious. It certainly can’t continue at this level.”
But most believe that the high-yield primary market is finally unfrozen. “The pace of it may not hold up but I do expect to see it continue as conditions get better and spreads come in,” said Dan Bastasic, vice president of investments for Mackenzie Investments. “There’s certainly enough cash on the sidelines and money coming into the high-yield space to entice companies to refinance debt. Companies are taking advantage of the fact that markets are open again. You’re going to continue to see a lot of refinancing of debt, which is a good thing. It’s going to continue to bring some balance to the market, as cash comes off the sidelines and goes into some of these new issues.”
Spreading the Good News
Speculative-grade spreads tightened significantly over the first half of this year, going from 1628 bps at the beginning of the year to 944 bps by June 18, according to S&P. The extent of the spread tightening surprised investors. “I thought we’d tighten by 100 [bps] to 200 [bps], but not over 800 [bps] at this point,” said Andrew Feltus, vice president and portfolio manger with Pioneer Global High Yield Fund. He said that the move in spreads across all ratings and asset classes has been a surprise as well. “The degree of the move has been shocking.”
Whether spreads will continue to narrow remains to be seen. As overall macroeconomic signals appear continually mixed, trading and spread levels may fluctuate accordingly. Investors see a continuing tightening trend. “I fully expect that spreads will continue to contract over a period of time and that will be a good opportunity,” said Bastasic. “The question is in the timing of it all. … I am confident that we will see spreads slowly grind in which will be positive for investors.”
Straddling the Big Default Line
While these other market conditions improve, corporate defaults are expected to continue to climb significantly. The U.S. speculative-grade corporate default rate will reach an all-time high of 14.3% by March 2010, according to Standard & Poor’s. By mid-June, the 2009 year-to-date tally reached 153, S&P says. That is more than four times the 35 defaults for the same period in 2008. The trailing 12-month U.S. corporate speculative-grade default rate at the end of the first quarter was 5.42%, more than triple last year’s rate of 1.72%. The long-term average default rate passed 4.34% in January for the first time in more than four years.
“We expect defaults are going to increase,” said Babson’s Fields. “We’ve positioned ourselves more conservatively. … You also have to be concerned if some of the liquidity in the market reversed itself. … That could bring another meltdown on the market. It’s very hard to read what real demand is both in the U.S. and globally. We had a hard stop and it’s hard to determine what the real level of economic activity is.” Fields added that she would not be surprised to see the recovery soften and slow down. And the persistent fear is of the overall economic situation.
“It still remains to be seen the degree of economic recovery we can have when we still have a hobbled consumer,” said Monaghan.
For more information on related topics, visit the following:
