Finance

Deepening Troubles in High-Yield Debt Markets

As the financial world grapples with the volatility and uncertainty of the debt markets, investors are encountering heightened risks, particularly within the domain of high-yield or 'junk' bonds. Spiraling concerns about a forthcoming default cycle are throwing the spotlight on the lowest-tier bonds as they become increasingly vulnerable, signaling troublesome times ahead for holders of corporate debt.

Source: Bloomberg, Moody's Analytics, Intercontinental Exchange and ECB

Corporate Defaults Surge as Investors Brace for Pain

(Bloomberg) -- The precarious nature of high-yield corporate debt is manifesting with increased defaults. Thames Water Ltd.'s holding company missed a significant £400 million ($504 million) bond payment, flagging wider issues in the market. This disturbing trend was preceded by Altice France's alarming revelation last month, where the telecom giant acknowledged investors must endure "discounted transactions" to facilitate the company's debt reduction efforts.

The repercussions for investors holding CCC-rated bonds — the riskiest classification — are severe, as indicated by the rising yields above benchmark bond spreads. In the last fortnight, the premium demanded for holding the shakiest European debt reached a pinnacle unseen since the darkest days of the Eurozone crisis and the industry-wide paralysis brought on by Covid-19. Although less pronounced, the American high-yield market is also experiencing a widening yield spread, compounding investors' apprehensions.

While sluggish economies have long been cushioned by the central banks' easy-money policies, the tightening of financial conditions through rapid interest rate hikes has started to suffocate companies struggling to roll over their debt. The liquidity tide is receding, and asset managers who once favored bonds from the lower spectrum to amplify returns are now facing looming haircuts on their investments.

"Anticipate some forthcoming anguish," warns Raphael Thuin, the lead strategist for capital markets at Tikehau Capital. He mentions that the conventional belief posits an 18 to 24-month period before the effects of rate hikes fully permeate. The current climate fits squarely within this critical window of financial impact.

Central Banks' Stance Rattles Credit Markets

With hopes dashed for a series of interest rate reductions this year, central banks, especially the Bank of England, have accentuated the increased perils of wider credit spreads. The finance avenues for risk-prone corporates are particularly susceptible to a profound decay in investor risk appetite.

The landscape is all the more precarious considering that European banks have notably decelerated the growth of corporate loans. Fitch Ratings projects that the default rate for high-yield bonds in Europe could ascend to 4% this year, leaping from 1.7% in 2023. Factors like soaring leverage, looming debt maturities, and faltering performances have been cited as drivers of this uptick in defaults.

Distinction in High-Yield Debt Performance

A particular detail that stands out in the mire of the junk debt market — both in Europe and the US — is the sustained tight spread in better-rated high-yield bonds. Investors are clustering into safer junk bond categories while deliberately avoiding the perilous CCC-rated debts.

"CCC’s have significantly underperformed," expressed Steven Fawn, global chief of credit at Amundi Asset Management, during an appearance on the Bloomberg Intelligence Credit Edge podcast.

Although the portion of CCC or below-rated debt summates to merely 8% of Europe’s junk bond index, according to Bloomberg Intelligence, the escalating issues are likely not to spread widely.

"Our extreme scenario envisages all credits with a rating of CCC- and below defaulting, yet the index's default rate remains below 2.4%" stated Heema Patel, a credit strategist from Bloomberg Intelligence, hinting at the possibility that the CCC index may be unfairly undervalued.

Downgrades Signal Warnings

In the drifting sea of ratings, several entities like Altice France SA and Samhallsbyggnadsbolaget i Norden AB have sunk into the CCC category. Kemble Water Finance Ltd., owner of Thames Water, has witnessed its rating slashed further.

"After a decade of free finances and negative interest regimes, some capital structures are simply unsustainable," cautioned Nicolas Jullien, a proficient manager of high-yield portfolios at Candriam SA.

For those interested in the evolving dynamics of the AT1 bond market, Amundi discusses expectations for these gains to continue in a recent podcast available here.

Credit Markets in Motion

Investors Seize Leveraged Loan Opportunities

A surge of capital is shifting toward US leveraged loan funds, instigating brisk gains within the credit sphere. The unyielding conviction resides in the slow descent of rates and the belief that junk-rated corporations in America will persevere despite towering borrowing costs.

KKR & Co.'s counterintuitive wager that leveraged debt would overshadow investment-grade fixed income last year bore fruit as recession worries waned and heightened interest rates laid siege to top-notch corporate bonds.

A propitious bet on a leveraged loan market rally subsequent to the volatility instigated by former UK Prime Minister Liz Truss’s botched financial plan in 2022 yielded a staggering 146% profit for a CVC Credit Partners' collateralized loan obligation.

Creditors of Thames Water Utilities have commenced organization in anticipation of prospective restructuring dialogs post the parent firm's debt default.

Apollo Global Management Inc. is in active negotiations to procure debt financing pivotal for Saks Fifth Avenue's potential capture of competitor Neiman Marcus.

Genstar Capital-backed Telestream aspires to accumulate roughly $400 million in fresh capital from direct lenders, aiming to alleviate its existing debt load.

Following a downgrade by Moody’s Ratings, Enbridge Inc. adeptly sold $3.5 billion of debt this Tuesday.

Challenges in Private Credit and International Borrowing

The private credit sector is witnessing hitches as direct lending funds grapple to garner cash from their benefactors, inciting fears of a cooling trend in the until-now flourishing private credit market.

Barclays Plc and AGL Credit Management, with support from the Abu Dhabi Investment Authority, are joining forces to carve out a niche in the burgeoning private credit arena, valued at an enormous $1.7 trillion.

Record issuance of Chinese yuan-denominated bonds outside China testifies to companies’ eagerness to leverage the relatively low borrowing costs associated with the currency.

Gains and Strategic Maneuvers Amidst a Shifting Landscape

An Ellington Management Group fund specializing in residential mortgage debt accrued around 24% since the onset of 2023 through January, benefiting from the anticipated end to the Federal Reserve's aggressive rate hike cycle.

Aroundtown SA's initiative to swap older hybrid bonds for new ones aims to restore equity recognition and sustain its credit ratings.

Herbalife Ltd. concluded a sale of $1.2 billion in high-yield bonds and leveraged loans after fortifying yields and incorporating lender-enticing safeguards to clinch sufficient participation.

99 Cents Only Stores LLC, operating in the discount retail segment, has elucidated plans to terminate its business operations.

Acorda Therapeutics Inc., specializing in neurological disorder treatments, has declared bankruptcy with a plan to sell its assets to a pharmaceutical competitor for $185 million.

Noteworthy Personnel Transitions

Viking Global Investors' credit head, Patrick Dowd, departs the hedge fund after a three-year tenure.

Northern Trust Asset Management has appointed Christian Roth as the Chief Investment Officer over their Global Fixed Income portfolio.

Steven Berger, previously a managing director at Rothschild & Co., makes a strategic career leap to Raymond James Financial Inc.

Effective from April 1, SMBC Nikko Securities America Inc. promotes Dolph Habeck to spearhead its sustainable solutions department.

-- With valuable insights from Helene Durand, Bruce Douglas, and Alex Nicholson.

Credit Market Prospects

The convolutions of credit markets elucidate the precarious juncture we are situated at currently. The cacophony of downgrades, creaking capital structures, and strategic hedges unfold in the broader narrative of a highly reactive market environment. As volatility pervades, investors and strategists alike will remain vigilant, calibrating their moves to the mercurial rhythms of global finances.

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