There’s a lot of bad news out of corporate America these days.
Bankruptcies are increasingly common, companies are struggling to make on-time interest payments and the latest earnings reports are expected to be disappointing. So it’s rather odd that investors are flooding into the most distressed bonds, with the debt set for its best two-month performance since 2009.
Even debt of officially insolvent companies has experienced a pop. Consider Energy XXI, which filed for bankruptcy protection on Thursday. Its bonds rose to 22.8 cents on the dollar from 10.8 cents in February. Something similar has happened to bonds of Peabody Energy since it filed this week.
The most distressed dollar-denominated bonds have surged almost 20 percent since the end of February, with energy-related notes leading the charge, according to Bank of America Merrill Lynch index data.
Why the popularity in what could be seen as the least attractive debt?
First, these bankruptcies aren't coming as a surprise. Indeed, investors in nondistressed debt have already abandoned these companies and left them in the hands of sophisticated asset managers who are weighing potential recoveries and ways to play in different capital structures. In some cases, it may make sense to own more debt that could be converted into equity, therefore creating demand for the beaten-up notes.
If anything, official restructuring sometimes means the end to a drawn-out process, full of negotiations that had given an air of uncertainty to investments.
Second, the gains are coming after a brutal year for commodities-related debt, which has caused most of the credit distress. Recently, there’s been an uptick in commodities price and a sense that values could be stabilizing.
And third, the more companies go belly up, the more business there is for all the remaining ones. Perhaps this is the beginning of a catharsis many have been waiting for.
That's not to say this rally in the most-beleaguered debt can't reverse easily and quickly. Crude oil prices are notoriously fickle and could easily retreat, leaving these highly levered companies with all-but worthless assets.
And credit traders may get less excited about bankruptcies as they really start piling up, especially if they come as a surprise in any way. Bankruptcies in the oil and gas industry could surpass levels seen in the Great Recession, with about 35 percent of exploration and production companies at risk of becoming insolvent, according to Deloitte. The 175 companies at risk have about $150 billion of debt and dwindling cash flows, the firm said in a February report.
For now, bankruptcies have been expected and orderly, and markets have taken them well. So well, in fact, credit traders appear to be cheering.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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