Junk-Bond Indigestion Seen Amid $11 Billion Glut: Credit MarketsCordell Eddings and Sridhar Natarajan
After swallowing $67.8 billion of junk bonds this year, the market is taking a breather.
Investors pulled $1.96 billion from mutual funds that invest in the riskier debt, snapping six weeks of inflows, according to data provider Lipper. The exodus comes as speculative-grade companies market an additional $11 billion of debt, including a $10 billion offering from Valeant Pharmaceuticals International Inc. that would be the biggest sale of the securities in almost a year.
Junk bonds are losing favor after staging a comeback from a rout brought on by the collapse in oil prices. Borrowing costs have climbed to 6.58 percent this week, the highest level in a month, according to a Bank of America Merrill Lynch Index, causing two issuers, Capital Product Partners LP and QVC Inc., to abandon offerings.
“The market is showing some indigestion,” John McClain, a money manager at Diamond Hill Capital Management Inc. in Columbus, Ohio, which oversees $15 billion, said in a telephone interview. “It’s harder to find value with a lot of companies taking a ‘now or never’ approach to the market, pouring a lot of supply into the market.”
Issuance of U.S. high-yield, high-risk notes in 2015 is 26 percent ahead of last year’s pace, according to data compiled by Bloomberg.
Valeant’s junk-bond offering to finance its takeover of Salix Pharmaceuticals Ltd. would be the largest since billionaire Patrick Drahi’s Numericable-SFR and Altice SA sold $16.6 billion in debt in April, Bloomberg data show. The drugmaker, with its executive offices in Bridgewater, New Jersey, is also raising loans to fund its purchase.
The onslaught of supply is weighing on returns. High-yield securities have lost 0.7 percent in March after gaining 2.4 percent in February, according to Bank of America Merrill Lynch Index data.
Capital Product Partners, a Greek shipping company, said Thursday it was canceling a $260 million junk-bond deal that would have gone to repay borrowings under its credit line.
QVC, the West Chester, Pennsylvania based television-shopping network, announced Wednesday it wasn’t pursuing a $250 million bond offering due to “current market conditions.”
The risk premium on the Markit CDX North American High Yield Index, a credit-default swaps benchmark tied to the debt of 100 speculative-grade companies, rose 3.2 percent this week to 319.2 basis points, the biggest weekly increase this year.
“You really have to sharpen your pencil and do your homework to get excited about anything at these levels,” Jack Flaherty, a money manager at New York-based GAM USA Inc., who oversees the firm’s $17 billion unconstrained bond fund, said in a telephone interview. “The lack of supply worked in the sector’s favor at the start of the year, but we’ve been hit with supply, and with that buyers have started turning into sellers.”
Even with the change in sentiment, terms are still attractive to borrowers as the Federal Reserve holds interest rates near zero. Moody’s Investors Service said in a report on Tuesday that investor protections in new U.S. junk bonds fell to the weakest level in at least four years.
“The U.S. economy is on very solid footing and the trajectory is upward, which provides solid underpinning for high yield,” said James Sarni, a managing principal at investment manager Payden & Rygel, which oversees $85 billion of assets. “There is still more demand than supply, and that will continue to support the market.”
That may not last forever, according to Sam Diedrich, a money manager at Pacific Alternative Asset Management Co., which oversees more than $9 billion.
Last year, investors dumped U.S. energy securities, as tumbling oil prices sparked concern that the speculative-grade debt that comprised 15 percent of the entire market would default. The bonds lost 7.4 percent, according to Bank of America Merrill Lynch index data.
Investors shouldn’t underestimate the risk of continued low oil prices, that have fallen by 56 percent since June and the growing expectations the Fed will raise rates later this year, said Diedrich,
“It’s not clear you are getting paid for the risk you are taking,” he said.