Azhar’s crunching credit – Bounce back October

In October, fixed income markets prepared themselves for a rebounding Donald Trump Presidency with the ’No Landing’ thesis of stronger growth than expected but also stronger inflation taking hold. This meant spreads tightened whilst government bond yields widened.

Key indicators

• The US 10-year Treasury yield widened by 51 basis points during the month to end at 4.29%
• High yield bonds outperformed investment grade bonds. Global investment grade returned -1.63% (+3.41% year-to-date) and global high yield returned -0.25% (+8.14% YTD).
• High yield spreads were 20bps tighter at 325bps, CCC’s were 49bps tighter, whilst single B’s were 16bp tighter and BB’s were 13bps tighter.
• Investment grade spreads ended tighter by 8bps at 93bps.
• The default rate fell by 0.2% to just 1.6%, this breaks down as US 1.3% (-0.1%), EU 2.5% (+0.1%) and Emerging Markets 2.8% (-1.2%). The gap between smaller issuers and larger issuers remained flat at 1.1% as the small cap default and large cap default rates remained at 1.5% and 0.4% respectively.

Issuance was robust in the month with $46bn in global high yield bonds, $95bn in investment grade bonds and $38bn in leveraged loans. This takes high yield volume to $423bn year to date. Investment grade is currently tracking at $1.3 trillion and loans at $440bn.

Bouncing back

Just as Trump has bounced back, this month we have three credits bouncing back: Boeing, Morrisons and Chobani.

We’ve commented on the lack of ‘fallen angels’ or downgraded investment grade issuers over recent months and over the last month we were preoccupied with following the saga over at Boeing, which with $53bn of debt on the brink of downgrade, is a capital structure that would make a sizeable splash in global high yield markets. Now the high yield market has had similar situations in the past – Both GM & Ford were infamously downgraded back in 2005 causing huge market digestion issues at the time (spreads widened from 280bps to 460bps) with the combined $86bn adding 13% to the $680bn market size. This time around, a downgrade would be a much more digestible 2.5% of the $2.1 trillion high yield market.

Now, Boeing is a huge company with over $110bn in equity value beneath the debt which makes it a very investable company, especially for creditors starved of supply, so many a high yield manager was looking enviously and hoping the name would get downgraded

Boeing has major issues, with flight regulators capping production of its most successful 737 aircraft whilst it is going through a major strike and at the same time as it is making an acquisition of its biggest supplier, Spirit Aerosystems. So, debt has ballooned by over $10bn whilst its cashflow has being hit hard and it expects to be free cash flow negative to the tune of $8bn in 2024 before returning to generate cash in 2025. Now, Boeing is a huge company with over $110bn in equity value beneath the debt which makes it a very investable company, especially for creditors starved of supply, so many a high yield manager was looking enviously and hoping the name would get downgraded and widen further from the 170bps in credit spread it was trading at.

Over the course of the month Boeing disappointed high yield investors as it raised a gigantic $21bn from its equity investors and combined this with settling a pay deal with its workers who called off the strikes. Credit markets reacted very positively, and spreads ended the month 31bps tighter at 139bps. 

The resilience of the company (Chobani) over recent years has been impressive after its regular unsecured bonds traded into the 80s cash prices just two years ago, however we do draw the line at quasi equity with a fixed income coupon.

Morrisons, the UK supermarket, had a very ill-timed leveraged buy-out in 2021 which has saddled it with a very high cost of capital and a debt heavy capital structure with maturities due in 2027. With food inflation crimping margins over the last few years, allied with discounters taking market share, increasing its debt costs was hugely ill-timed and many have worried about whether this was a step too far for the private equity buyers. Luckily animal spirits have returned to all leveraged markets and the company returned to the market in October to extend out its leveraged loan maturities from 2027 to 2030. 

And finally, we have a ‘Preferred in Kind’ or ‘PIK’ story, we have spoken before about PIKs, they are usually used by indebted borrowers who can’t afford to pay the cash interest and tend to be instruments used at a time of market overheating. This month we had Chobani, US Greek yoghurt maker, come to the market to issue a $500m CCC rated PIK with an 8.75% coupon to refinance equity. The resilience of the company over recent years has been impressive after its regular unsecured bonds traded into the 80s cash prices just two years ago, however we do draw the line at quasi equity with a fixed income coupon.

So, three bounce backs feeding into the political bounce back story of our age but I think we have probably all read too much about politics over the last few days so we will leave that for next month’s edition.

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.