Azhar’s crunching credit - September: Public markets fight back

September was another strong month for fixed income returns as spreads stayed tight and government bond yields tightened.

Key indicators

• The US 10-year Treasury yield tightened by 12 basis points during the month to end at 3.78%.
• High yield bonds outperformed investment grade bonds. Global investment grade returned 1.51% (+5.12% year-to-date) and global high yield returned +1.56% (+8.42% ytd).
• High yield spreads were 12bps tighter at 345bps, CCC’s were a staggering 118bps tighter, whilst single B’s were 6bps tighter and BB’s were 5bps wider.
• Investment grade spreads ended tighter by 4bps at 100bps.
• The default rate fell by 0.3% to just 1.9%, this breaks down as US 1.4% (-0.3%), EU 2.8% (+0.6%) and emerging market 4.0% (-0.8%). The gap between smaller issuers and larger issuers increased by 0.5% to 0.9% as the small cap default rate fell by 0.1% to 2.0% whilst large cap default rates were down 0.6% to 0.5%.

Issuance was robust in the month with $43bn in global high yield bonds, $161bn in investment grade bonds and $69bn in leveraged loans. This takes high yield volume to $364bn ytd, (versus $285bn last year).  Investment grade is currently tracking at $1.2 trillion (vs $1.1trillion last year) and loans at $399bn (vs $233bn last year).

A big theme over the last few years has been the rise of private credit and the quantum of monies raised (the direct lending funds now comprise more assets than the entire US high yield market,) which has played a significant part in providing liquidity to issuers over the last few years mitigating stress and muting the default rate.

We think private debt has not displaced liquid debt but played a role in providing capital to issuers – especially smaller companies and weaker more stressed companies that the public markets find challenging to price. Many examples of which we have written about in recent months.  Public markets particularly struggle in a rising default climate as they tend to overreact, with the last few years providing evidence of this as credit spreads widened in 2022 anticipating stress that didn’t occur. This meant that many issuers would have struggled to refinance without the capital that private markets could provide.

Coming to the current period with credit spreads at historically tight levels and yields at levels companies are very much used to borrowing at, and importantly below the levels direct lending companies have promised capital to their end investors, we are seeing quite an interesting phenomenon which is the return of issuance from private to public markets, and one example in the month was Evri.

Evri is an interesting company – one which most UK based readers will no doubt have heard of. The parcel delivery company has thrived post pandemic, carving out a niche in the lower cost segment and came to raise debt in the public markets post a sale of the business from Advent to Apollo. As part of this sale the existing privately held debt was extinguished by a bridge loan which was in turn refinanced into a publicly syndicated bank loan and a high yield bond, with the company raising £1.4bn including a £725m high yield bond (upsized from an original £500m) at 8.125%. As a B+ rated company, Evri’s cost of capital via this bond was equivalent to 435bps replacing a historic funding level of 650bps from the private markets.  It’s an interesting example of where private capital can’t out compete public markets.

One company with a long history of operating in public syndicated loan markets is Belron, the market leader in vehicle glass, repair, replacement and recalibration and known to many under its brand names such as Autoglass, Carglass and Speedyglass. Belron’s size (revenue over €6 billion and enterprise value around €15 billion) makes it far too big for private markets and it came to the public markets for a giant €8bn package including almost €2bn in bonds to refinance existing debt and pay out a dividend to effect a change in ownership.

This gigantic relevering transaction (raising an additional €4bn of debt) really shows the current strength of public markets. Belron was able to extract huge value by borrowing at a much lower rate than the new credit metrics (5x leverage) or BB- rating should have implied and more interestingly was able to issue high yield bonds with a 4.625% coupon in euros and a 5.75% coupon in dollars (that’s credit spreads of 269bps in euros and just 222bps in dollars), with a 5-year maturity and the ability to call this after two years with an added ‘soft call’ optionality allowing the issuer to repay 10% of the debt each year at a price of 103. We’ve never been huge fans of this type of capped fixed income instrument in the bond world (as bond investors convexity is already against us) and attests to a particularly perfect financing climate for large established issuers.

So, a month where public markets seem to be finding their confidence and fighting against the narrative that this is solely a golden age for private credit. The size, breadth and depth of public markets is not something to be underestimated.

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.