Junk Bonds Drop Below Par as Asia Suffers China: Credit Markets
For the first time since August, junk bonds are trading below par amid speculation that companies will have a harder time meeting debt payments as the Federal Reserve prepares to reduce its extraordinary stimulus measures and China reins in its shadow-banking system.
Average prices on speculative-grade corporate notes dropped to 99.42 cents on the dollar on June 25, from a record 106.04 cents in May, according to Bank of America Merrill Lynch’s Global High Yield Index. The declines were led by Asia, which saw prices tumble to 97.2 cents, the lowest level in a year.
Central bank largesse has allowed companies to avoid default by refinancing debt at ever lower interest rates, encouraging investors to bid up the price of their bonds. Moody’s Investors Service said June 25 that investors pulling money from high-yield funds threaten to derail stable credit conditions for the riskiest companies.
“Fears of a slowdown in China are back to the forefront but the main driver of the selloff is tightening liquidity,” said Salman Niaz, a Singapore-based bond fund manager at Goldman Sachs Asset Management. The firm had $748 billion invested globally on March 31.
Returns on junk bonds worldwide are flat this year through June 25, after soaring 18.8 percent in 2012, including reinvested interest, the Bank of America Merrill Lynch index shows. In Asia, investors have lost 3.1 percent, following a 26 percent rally last year.
A measure of the average yield investors demand to own the bonds has surged to 6.81 percent from this year’s low of 4.61 percent on May 9, according to the Bloomberg Global High Yield Corporate Bond Index. (BHYC) Even with the increase, rates are below last year’s high of 8.79 percent on Jan. 2, 2012.
The slump in the junk bond market “is justified because it was overvalued previously,” said Martin Fridson, the chief executive officer of New York-based FridsonVision LLC, a research firm that specializes in high-yield debt. “It requires some shock to get it back to fair value.”
Fed Chairman Ben S. Bernanke said last week the central bank could begin to reduce the $85 billion of mortgage and Treasury bonds it buys each month if the U.S. economy continued to show sustained improvement.
In China, Premier Li Keqiang’s efforts to rein in shadow banking stoked the worst credit crunch in China in at least a decade, driving up funding costs for Asia’s weakest borrowers. China’s benchmark money-market rate averaged 6.97 percent in June versus 3.30 percent the first five months of the year, threatening to freeze the interbank market.
Nomura Holdings Inc. sees a 30 percent chance that growth in Asia’s biggest economy will dip below 7 percent in the second half, after averaging 10 percent a year since 2000.
Elsewhere in credit markets, the cost of protecting corporate bonds from default in the U.S. fell for a third day. The Markit CDX North American Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, decreased 2.2 basis points to a mid-price of 85.8 basis points as of 1:08 p.m. in New York, according to prices compiled by Bloomberg.
The index, which ended June 24 at the highest this year, typically falls as investor confidence improves and rises as it deteriorates. 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 15.2 basis points as of 12:50 p.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 Bank of America Corp. are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 3 percent of the volume of dealer trades of $1 million or more as of 1:09 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
The Bloomberg Global Investment Grade Corporate Bond Index (BCOR) has lost 2.45 percent this month, bringing the decline for the year to 4.17 percent.
Investors have pulled $13.7 billion from global bond funds in the four weeks ended June 19, data published by EPFR Global show. Some $6.9 billion exited emerging-market funds, the most since 2011, and $1.8 billion left Asia markets outside Japan.
Moody’s said earlier this month that it now expects the global speculative-grade default rate to rise to 3.1 percent by year-end, from 2.6 percent in April.
“Investors who can be satisfied with rising yields on non-risk Treasuries are shifting money to safer assets,” said Manabu Tamaru, a Tokyo-based fund manager who helps oversee $528 million of fixed-income investment at Baring Asset Management (Japan) Ltd. “If you’re targeting a return of say 2 to 3 percent, and that can be achieved with Treasuries, you’re going to want to sell high-yield.”
The market value of bonds in the Bank of America Merrill Lynch’s Global High Yield Index has fallen $71.2 billion to $1.79 trillion from a peak of $1.86 trillion in May.
Bonds in Asia have been particularly hard hit, with 82 of 157 securities in Bank of America Merrill Lynch’s Asia index trading below par on June 25, compared with 14 when the market peaked at $73 billion on May 13. Yields on the securities rose to 7.39 percentage points more than Treasuries on June 25, from a more than two-year low of 5.52 percentage points on May 10.
Debentures of Chinese builder Kaisa Group Holdings Ltd. (1638) due January 2020 fell below par this month for the first time since February, prices compiled by Bloomberg show. Indonesian power producer PT Indika Energy’s January 2023 notes have dropped to 85.3 cents on the dollar from 103.8 in April, the data show.
Bond sales have slowed as Asia’s weakest borrowers shunned the highest funding costs in 10 months.
Chinese corporates led $14.5 billion of offerings denominated in dollars, euro or yen in the first three months of the year, a record quarter since Bloomberg started compiling the data in 1999. U.S. junk-bond sales rose 37 percent to $201.1 billion this year versus the same period of 2012, including $108.9 billion in the first quarter.
“It’s likely the pace of new dollar issuance will slow,” Goldman’s Niaz said. “The higher cost of money and limited refinancing options will make it challenging for some businesses and put pressure on credit quality. However fundamentals are strong, so investors will be interested at the right price.”
China Central Real Estate Ltd., based in the mainland’s Henan province, was the last Chinese speculative-grade company to issue, selling $400 million of five-year bonds on June 4. The 6.5 percent notes, sold at par, were trading at 89.3 cents on the dollar yesterday to yield 9.24 percent, Bloomberg prices show.
Vedanta Resources Plc (VED), the London-based oil and metals group controlled by Indian billionaire Anil Agrawal, raised $1.7 billion last month in Asia’s biggest fundraising by a high-yield company in 2013. Its 6 percent notes due January 2019, also sold at par, were trading at 95.2 cents on the dollar yesterday, yielding 7.05 percent.
“Liquidity was poor in cash markets generally because investors were reluctant to buy, thinking prices may fall further,” said Joyce Tan, the head of Asia fixed-income in Singapore at UOB Asset Management Ltd., which manages $26.8 billion. “After rallying since 2009 on lower interest rates and narrower credit spreads, the market’s going to take some time before finding a new equilibrium.”
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