Junk Bond Froth Leaks Into Emerging Market Debt: Credit Markets
Junk bonds of companies in emerging markets are the most expensive in seven years relative to the U.S., underscoring concerns by policy makers from Mexico to the Philippines who say the threat of asset bubbles is increasing.
Speculative-grade securities from nations including China and Brazil returned 14.8 percent since end-June, versus 9.4 percent in the U.S., according to Bank of America Merrill Lynch indexes. Emerging-market yields fell to 7.3 percent from 9.3 percent a year ago even as net debt rose to a record 3.02 times earnings before interest, taxes, depreciation and amortization, data compiled by Bloomberg show. The median yield-to-leverage ratio of 2.4 compares with 2.1 in the U.S., the smallest premium since 2005, the year before developing-nation returns lagged behind.
“If global economic conditions remain sluggish, high-yield companies will be at risk given their high leverage,” said Brigitte Posch, an executive vice president at Newport Beach, California-based Pacific Investment Management Co., manager of the world’s largest bond fund. “Going forward being selective is extremely important.”
Investors repressed by near-zero benchmark interest rates in the U.S., the euro region and Japan are paying up for debt in developing nations at the same time the International Monetary Fund says the economies will expand less than the decade average. Junk-rated companies, including Chinese property developer Hopson Development Holdings Ltd., raised $18 billion last month, or 44 percent above the previous record in May 2011.
Posch, whose firm manages the $285.6 billion Total Return Fund, said in a Feb. 12 e-mail that she has pared holdings of some emerging-market corporate debt with “tight valuations” the past few months, while looking to add “good credits.”
When the yield-to-leverage ratio for junk borrowers in emerging markets fell this low versus American peers in 2005, the developing-nation index returned 9.3 percent the following year, trailing the 11.8 percent gain in the U.S., Bank of America Merrill Lynch indexes show.
The ratios measure how well investors are compensated relative to the company’s debt level. A higher reading indicates better risk-adjusted returns.
Emerging market businesses have been adding debt even as profit growth slows and borrowing costs stop tumbling. Ebitda at companies in Bank of America Merrill Lynch’s high-yield index increased 9.5 percent in the past 12 months, less than half the 23 percent pace a year earlier, data compiled by Bloomberg show.
“The quality of bonds issued now is lower than it was six months ago,” Guillermo Osses, who oversees $15 billion as the head of emerging-market debt at HSBC Asset Management in New York, said in a telephone interview on Jan. 18. “This is difficult to sustain,” said Osses, who has reduced holdings of high-yield corporate bonds.
J&F Participacoes SA, the Sao Paulo-based parent of the world’s biggest beef producer, and Schahin Oil & Gas Ltd., a Brazilian rig operator, both postponed debt sales this month as borrowing costs rose.
Elsewhere in credit markets, the cost of protecting corporate debt from default in the U.S. fell. The Markit CDX North American Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, decreased 0.6 basis point from Feb. 15 to a mid-price of 86.2 basis points as of 11:41 a.m. in New York, according to prices compiled by Bloomberg.
Markets were closed in the U.S. yesterday for the Presidents’ Day holiday.
The index typically falls as investor confidence improves and rises as it deteriorates. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
The U.S. two-year interest-rate swap spread, a measure of debt market stress, was little changed at 15.25 basis points as of 11:41 a.m. in New York. The gauge narrows when investors favor assets such as company debentures and widens when they seek the perceived safety of government securities.
Bonds of JPMorgan Chase & Co. are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 4 percent of the volume of dealer trades of $1 million or more, at 11:42 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
A growing number of policy makers have expressed concern that credit markets are overheating after Bank of America’s gauge of global junk debt jumped 115 percent in the past four years, outpacing the 91 percent total return from the MSCI All- Country World Index of shares.
Funds investing in developing-nation bonds attracted $13.5 billion this year, after drawing a record $97 billion in 2012, JPMorgan said in a Feb. 15 note.
The “credit booms” in emerging markets may leave them vulnerable to a reversal in capital flows once advanced-country policy makers pare back monetary stimulus, Mexican central bank Governor Agustin Carstens said in a Feb. 5 speech in Singapore.
Philippine central bank Governor Amando Tetangco said on Jan. 15 in Manila that he’s focused on containing speculative inflows that may spur asset-price bubbles. Thai central bank Governor Prasarn Trairatvorakul echoed that concern in a policy address in Bangkok on Jan. 22.
U.S. Federal Reserve Governor Jeremy Stein said Feb. 7 that investors’ “fairly significant pattern of reaching-for-yield” doesn’t “bode well” for speculative-grade debt.
Average emerging-market corporate yields have climbed 21 basis points, or 0.21 percentage point, from a more than seven- year low of 7.04 percent on Jan. 23. Yields for American junk bonds rose 12 basis points to 6.56 percent.
Investors submitted bids for new emerging-market corporate bonds last month that were on average 10 times the amount being offered, up from four times a year earlier, Bank of America said in a Jan. 31 report. High-yield sales accounted for 43 percent of the total, above the three-year average of 27 percent.
Investors have begun “to care less about whether or not a bond compensates them appropriately and more about whether the bond compensates them at all,” Chris Hays and Oleg Melentyev, New York-based strategists at Bank of America, wrote in the report.
The Washington-based IMF cut its 2013 growth forecast for developing nations to 5.5 percent on Jan. 23 from a previous estimate of 5.6 percent. While that’s slower than their average growth rate of 6.6 percent during the past decade, it’s still faster than the 1.4 percent pace projected for advanced nations.
Emerging market companies are borrowing to finance expansion opportunities and yields are high enough to compensate investors for the risk of a selloff in global debt markets, said Philip Meier, an emerging-market money manager at DWS Investments, which oversees 283 billion euros ($378 billion).
“Investors are still keen on adding emerging markets corporates exposure,” said Meier. “We expect the emerging markets discount to narrow further in a positive market environment in 2013.”
Hopson Development, a Beijing-based property developer that increased net debt to 14 times Ebitda as of June from 4.1 times a year earlier, sold $300 million of five-year notes on Jan. 9.
The securities, rated CCC+ by S&P, or seven steps below investment grade, were priced to yield 9.875 percent. That compared with 10.2 percent for similar-rated bonds globally and an average 15.5 percent for emerging markets, data compiled by Bloomberg and Bank of America show. The bonds have lost about 2.1 percent.
Gol Linhas Aereas Inteligentes SA, Brazil’s second-largest carrier, sold $200 million of 10-year bonds on Feb. 7 with an 11 percent yield. The debt, rated B- by S&P, has slipped to 98.5 cents on the dollar from an issue price of 98.51.
The airline is cutting flights, firing workers and seeking to renegotiate covenants on local securities after losses in five of the past six quarters. Adjusted net debt climbed to 14.3 times trailing 12-month earnings before interest, taxes, depreciation, amortization and rent in the third quarter from 6.7 times a year earlier, the company said on Nov. 13.
“When you see massive credit issuance, it comes hand in hand with the slippage of underwriting standards,” said Michael Shaoul, the chairman of New York-based Marketfield Asset Management, whose $6.1 billion MainStay Marketfield Fund has outperformed 96 percent of peers the past five years. “The class of 2013, 2012, 2011 will have much worse credit conditions than we are used to.”
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