....interesting for this article to pop up after just watching Michael Antonelli speak (to Michael Gayed).
....well, as we learnt from Michael, the high yield debt market is dominated by companies in the energy space, and with high oil price, of course their yield spread is not rising as fast. But as we saw with Uniper in Germany requiring national bailout, we can imagine what could possibly happen in that HY debt market when oil price start falling quickly.
....so if oil prices stays high, it makes the Fed pivot more difficult. but if oil prices come sharply down, that may not help the HY debt market. Can't seemingly win here. The US high-yield market starts to unravel
Highly geared companies are facing a sharp jump in borrowing costs as nervous investors shy away from risk. Karen MaleyColumnist
Jul 5, 2022 – 6.41pm
Risky corporate borrowers are now emerging as one of the biggest casualties of central bank tightening.
For years, companies – even those with low credit ratings – have been able to take advantage of ultra-low interest rates and plentiful liquidity to issue copious amounts of debt.
But that situation is changing fast, the collision between rising interest rates and growing recession fears has driven investors away from risky assets.
In particular, investors have been dumping high-yield bonds – which also go by the less flattering name of junk bonds, pushing yields sharply higher. (Yields rise as bond prices fall.)
Investors fear that default rates will move sharply higher, as the economy slows, and debt-laden companies struggle to make their loan repayments. Especially given that sharp increases in fuel and labour costs will squeeze corporate cash flows.
As a result of this selling, the average yield in the $US1.7 trillion ($2.5 trillion) junk bond market has now jumped to around 8.5 per cent (up from less than 5 per cent at the beginning of the year). And the bonds issued by the more heavily indebted companies – those with a triple C rating – now yield around 14 per cent.
The steep increase in bond yields has also left investors concerned that some highly leveraged companies will struggle to refinance their debt as it matures, or that they’ll be forced to pay extremely high interest rates to entice investors to hold their bonds.
What’s more, some analysts believe that junk bond yields will push even higher, as recessionary worries intensify.
They point out that the current yield gap – known as the spread – between junk bond yields and US government bonds is about 5.5 percentage points, which is not all that large in historic terms. In recessions, spreads for junk bonds usually climb above 7.5 percentage points.
The twin scourges of rising interest rates and a darkening economic backdrop has also caused investors to pull back from the $US1.3 trillion leveraged loan market.
Indeed, leveraged loans are seen as even more exposed to higher rates, given that the interest rates on these loans are floating, rather than fixed, and the covenants which restrict borrowers from taking on additional debts have been consistently watered down.
Typically, investment banks share in the underwriting of massive leveraged loans on takeover deals, and then proceed to offload them to other investors, such as institutional investors.
But when investors start getting nervous about leveraged loans – which are risky because they are often used to finance debt-heavy takeover deals – investment banks are forced to offer large discounts in order to offload these debts.
According to a report in the Wall Street Journal, Bank of America, Credit Suisse and Goldman Sachs “are among the banks that could collectively lose billions of dollars on buyout loans they agreed to provide when demand for the debt was running high”.
Not surprisingly, the freezing up of the leveraged loan market has put a dampener on takeover activity.
Last week, US department store Kohl’s Corp abandoned its proposed $US8 billion sale to Franchise Group, which owns retail brands including Vitamin Shoppe.
Meanwhile, investors are keeping a close watch on one of the biggest buyout financings of the past decade – the $US16.5 billion takeover of US cloud-computing company Citrix Systems by two private equity groups.
The deal, which was agreed in January, is to be funded with about $US15 billion of buyout debt. But the weakened appetite for leveraged loans will make it difficult for the investment banks that underwrote this debt to offload it without taking a haircut on their exposure.
