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Categorized | Capital Markets

Junk bond rally stirs memory of credit boom


Posted on January 31, 2012

Junk bonds, until last year one of the favoured post-crisis asset classes for many investors, are enjoying a vigorous rally that has drawn comparisons with the credit boom.

US corporate debt rated below investment grade, or junk, has notched up a 3 per cent return this year, according to Barclays Capital, a strong rebound from last year’s sell-off as the eurozone crisis intensified. Issuance has reached $19.5bn, Dealogic says. Ford led the way with a $1bn deal at the start of January.

Click to enlarge

The bombed-out European market has performed even better as a result of the European Central Bank’s emergency loans to banks, which has revived risk appetite. European junk bonds have returned 5.3 per cent to investors and issuance has rebounded to almost $6bn.

“We’ve seen nothing like it [in Europe] since the halcyon days before the subprime crisis,” Suki Mann, a strategist at Société Générale said in a note last week. “This is effectively a massive rally in credit. The message isn’t hidden or subtle: buy corporate bonds, simple. Rather add risk, any risk and there’s no point in being measured about it.”

Nonetheless, caution remains on both sides of the Atlantic. Bankers, investors and analysts warn that the high-yield debt markets are susceptible to the same risks that undermined the markets late last year.

“There has been more money thrown at the problem but the risks that we saw in the latter half of 2011 have not been resolved,” says Bonnie Baha, head of global developed credit at DoubleLine Capital. “Absent better economic growth in the US and a resolution in Europe, this is another head fake.”

Another stumble on the road to fiscal health in Europe or signs that US economic growth is slowing could reignite a “risk-off” slide that sends junk bonds lower, Ms Baha adds. Europe’s high-yield debt market looks particularly vulnerable. While investors have poured almost $7bn into US high-yield funds in the four weeks to January 25, only $12m has dripped back into European funds, according to EPFR Global.

High cash balances at funds that sold many of their holdings of lower-rated debt, an illiquid secondary market and the recovery of risk appetite triggered by the ECB’s almost €500bn of three-year loans to banks have eased the way for new bonds. Yet bankers are doubtful that the flow of deals will continue at the same clip.

“For all intents and purposes, the European high-yield market was closed in the second half of last year, so there was a backlog of deals to take to the market and investors had cash they wanted to place,” says Kristian Orssten, European head of high-yield syndicate at JPMorgan. “But it’s still fragile.”

A replay of Europe’s second-half junk bond freeze could cause difficulties at some lower-rated companies, which face problems borrowing from banks.

The US, too, looks susceptible to a fresh bout of risk aversion. Some macroeconomic data have improved but seasonal factors make it hard to read, says a US chief investment officer: “It would be wrong to assume that the US is anything as robust as the recent figures would suggest.”

What is more, this year’s fund inflows have been mostly through exchange-traded funds, a type of fund that trades, like stocks, on an exchange. Such funds have grown in popularity across asset classes in recent years partly because they allow investors to react quickly to changing market conditions.

“One of the reasons you are buying an ETF is the ability to press a button and get rid of it,” says Ashish Shah, head of global credit at AllianceBernstein.

If demand dissipates and borrowing costs jump sharply as they did last year, it could be particularly troublesome for European companies.

Many US companies refinanced their pending debt maturities during the previous rally. That has left a group of “walking dead” companies who may be unable to refinance debts. However, overall maturities are relatively low over the next few years, Mr Shah says.

On the other hand, a large number of European companies could well depend on the US markets remaining open to augment the European investor base. Of the $19.5bn of junk bonds sold in the US this year, more than $5bn have been issued by companies domiciled in Europe. “A less robust US market could be felt more by the European companies,” says Martin Fridson, global credit strategist for BNP Paribas Investment Partners.