Azhar is talking about global credit – April showers?

This is a new monthly blog in which I will be sharing market news, thoughts and views from a global credit perspective.

It has been unseasonably cold (and seasonally wet) in London this month with markets also dampening from March’s banking excitement – so let’s look at some of the key indicators, market news and our current thinking.

Key indicators

• Global high yield spreads ended the month at the 435bps mark, so 15bps tighter than they started the year. High yield market yields are 7.8% so 40bps tighter than the start of the year and a good 60bps tighter than the wides we saw in March.
• Global investment grade spreads are 151bps, unchanged from the start of the year and 22bps tighter than the March wides, with yields at 4.9%, 20bps tighter than the start of the year.
• Defaults continue to be contained – last 12-month rates are at 1.7% in the US high yield market, US leveraged loan defaults are notably higher over the last few months as we’ve seen some big issuers default, but are still low in absolute terms at 2.1%.
• That’s the first time in 10 years that the leveraged loan default rate is higher than the high yield bond default rate – a trend we expect to continue as the loan market is lower in quality and the high yield bond market higher in quality than previous years. The European high yield bond default rate is 0.4%. Emerging markets corporate default rates continue to fall after last years ‘Annus Horribillis’ caused by Chinese property and the Ukraine war/Russian sanctions, with the rate running at 1.9% year to date (it was 14.1% last year).

Key concerns

• US debt ceiling worries are starting, US one-year Credit Default Swap (CDS) spiked to 177bps, and one-month T-bills are trading inside the Federal Funds rate. Now a CDS instrument on the US is quite quirky and leaving aside the debate around its value, the fact that it is trading above the levels we saw when the last debt ceiling debate got ugly (2011) means we should take note.
• US regional banks continue to worry – First Republic is the current casualty with JP Morgan absorbing its assets after its debt and equity were wiped out at the month end.

Market news

• High yield issuance was back, with mainly refinancing deals seen in Europe and the US, notably Travelodge (asset-light UK budget hotel operator) refinanced its debt (also paying a dividend to its owners) with new debt issued at 10.625%. In Europe, we saw Italian bottle manufacturer, Bormioli refinance its 2025 bonds with new debt (issued at a 4.5 point discount) to yield 9.9%. In the US, we saw buyout debt for the acquisition of software company Citrix that had been bridged and was sitting on investment banks balance sheets, get placed at deep discounts. The $3.8bn second lien tranche came at a 21(!) point discount with a 9% coupon to yield 14% and traded up over five points. It’s a healthy sign that the banks are willing to take the losses on this debt and syndicate it on as it gives them the capacity for newer deals.
• The credit story of the month was United Group – the telecom and media operator with operations in Central and Eastern Europe, which has a large and deep capital structure with €5.1bn in debt across 13 tranches. Whilst operational performance has been good, its geographical region of operations and upcoming debt maturities have meant it has come under sustained pressure, with short sellers of its bonds and buyers of its CDS causing some turbulence, leading to its shorter duration debt yielding over 7% and its longer dated debt over 11%. In the month, it divested some of its telecom tower assets for a huge multiple (25x!) with the proceeds earmarked to refinance its 2024 and 2025 bonds reducing overall leverage from 5x to 4x. It’s a reminder for us that whilst larger capital structures often suffer far more volatility along the way (the cost of being liquid!), ultimately, they have far more options to repay debt maturities – a theme we think is going to be increasingly important as credit conditions tighten. The growth of high yield markets, in terms of issuer size, is something which hasn’t been much remarked upon but it’s a facet which I certainly think will reduce default risk as this next default cycle begins.

Our views

• I think global high yield defaults will rise this year to around 4-5% (and don’t see huge disparities regionally) and high yield spreads are priced for this with the main unknown being the quantum of additional spread needed for volatility. However, I think the front end is very cheap, with the combination of a flat spread curve and inverted government yield curve creating yields we haven’t seen in a decade, whilst near-term default risk is low due to small maturity walls.
• In most of our longer dated high yield portfolios, we like the combination of shorter spread duration and longer interest rate duration to protect against the inevitable accidents that tightening policy after such a long period of low rates will create. Given the uncertainty of what level inflation (and therefore interest rates) will settle at, we think it’s important to focus on sustainable levels of income above the respective benchmarks.

This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.