Azhar’s crunching credit – November sees stunning yield reversal

November was stunning in the magnitude of the reversal in yields with spreads and rates substantially tighter leading to a record return month across fixed income markets.

Whilst it ended up being the best month in 38 years for investment grade bonds, it was simply the best month since last summer for the high yield market.

Key indicators

• The US 10-year treasury yield compressed 65bps during the month to 4.25%.
• Investment grade bonds outpaced high yield bonds. Global investment grade returned +4.48% and global high yield +4.08%.
• High yields spreads tightened to 427bps, 55bps tighter on the month, spreads compressed – CCC’s were 88bps tighter, single B’s 63bps tighter and BB’s 49bps tighter.
• Investment grade spreads – tightened by 19bps to 123bps.
• Investment grade bonds have now returned +4.45% return year-to-date, high yield markets have delivered +8.71% year-to-date.
• The default rate fell in the month to 2.8%, this breaks down as US 3.4%, EU 1.4% and emerging markets 6.8%.
• The gap between small cap and large cap default rates rose in the month from 1.8% to 2.2% with small caps at 3.8% and large caps at 1.6%.

Credit stories

Spirit AeroSystems came to the market with a $1.2bn 2030 bond that priced at 9.75% refinancing a $1.2bn 7.5% 2025 maturity. Another example of an issuer proactively dealing with its maturity wall. In this case the company was able to preserve first lien capacity, important for a company which is hugely geared to the economic cycle as the supplier of aircraft components to key manufacturers Boeing and Airbus. The company also raised $400m in additional equity and a convertible note all to bolster liquidity ahead of a seasonal cash burn period.

Some market participants have written extensively on the rising wall of debt in the credit markets as a concern – it’s not something we see as a major issue at this point in the cycle. With less than 10% of the overall market’s maturities in the next two years we don’t think this will be a cause of a spike in defaults and, as this example amongst others shows, we think issuers are already proactively dealing with upcoming maturities where they are sizeable relative to their capital structures.

EG Group, the global petrol station operator, is another name we have spoken of before – a company which had created a tower of debt maturing in 2025 that has been able to extend out its maturities over the course of this year. In this case the average cost of debt has doubled for the issuer so it’s interesting that in its most recent refinancing they used a part cash/part ‘pik’ (payment in kind) interest payment solution to refinance term loan maturities. This ‘pik’ interest is noncash pay and accretes as additional debt – a solution often found by cash strapped borrowers to defer default. The $500m floating rate instrument was issued at a price of 97 and was provided by a private debt provider. This is a trend we have seen repeatedly this year as issuers utilise the greater capacity and flexibility of the private markets to increase liquidity and flexibility, and ultimately reduce the default risk over the next few years.

First Quantum, a copper miner was in the news as its largest project in Panama got into political trouble. The concession contract has become a huge political issue with an unpopular president declaring the contract unconstitutional and asking for a referendum on the contract. Interestingly the impact is much larger for Panama with a closure of the mine having up to a 4% GDP impact. First Quantum’s bonds moved 300bps wider on the news to yield 12%, the company is large enough now to absorb the loss of the contract, but leverage would rise from 2.1x to 6.2x in this event – sufficient to move the credit from a B+ down to CCC terrain.

Last, and firmly least, we had a Sanjeev Gupta owned entity – Infrabuild Australia – borrow $350m at an eye watering 14.5% for a 2028 maturity. The bond had to come at a discount at 98 to yield 15.08% and was issued to refinance a 12% $350m 2024 bond. Sanjeev Gupta has come under scrutiny as the Serious Fraud Office is investigating suspected fraud, fraudulent trading and money laundering at GFG Alliance entities. Infrabuild is an Australian steel manufacturer and what is worrying is that this bond would release proceeds to pay a dividend down to Gupta, whilst leaving debt in place which is covenanted such that any charges brought on Gupta would lead to acceleration and thus likely default. Like many investors we were puzzled at why anyone would be willing to lend proceeds when such a risk is so tangible but, as this issuance proves, it seems there is a clearing price for all risks.

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.