WASHINGTON: It was a panicked message from a colleague that woke fund manager Ivelina Green at 5am last Thursday in New York: “Total meltdown.”
The average risk premium for US high-yield debt had climbed to a 17-month high and primary markets notched the year’s biggest spate of pulled deals.
In London, Arini Capital Management, one of the biggest hedge fund investors in the high-yield market, just told investors it had lost 6.9% in the first half of October.
Parts of the high-yield market were seeing a rapid downturn, triggered by intensifying investor concerns about how the most vulnerable companies will withstand elevated inflation, rising interest rates and the business impact of artificial intelligence (AI), all against a volatile geopolitical backdrop.
Yields on the riskiest junk borrowers, rated CCC, last week surged to their highest since the pandemic, as the spread they command over Treasuries ballooned to a four-year high.
While software has been the focus for much of this year because of fears over the disruptive powers of AI, cable and satellite companies have been the biggest laggards in this portion of the market.
“The price action has been eye-watering in a lot of situations,” said Green, founder and chief investment officer of London-based credit investor Pearlstone Alternative.
“Into year-end, primary markets are effectively shut. And there isn’t a lot of liquidity on the way down, so that is exacerbating the panic.”
The pain underscores how credit markets have grown far trickier for the riskiest borrowers. After raising billions during a period of unusually low rates, these companies are now facing increasingly sceptical investors reevaluating their business prospects in an AI era and questioning their ability to refinance and service debt at much higher costs.
For investors, last week’s declines reinforce the importance of picking solid credits. For companies that go bad, investors might end up recovering far less than usual, said David Colla, global head of credit investments at CPP Investments, which managed more than US$600bil of assets as of June 30.
“That’s the heartache in people’s portfolios right now,” Colla said in an interview.
Yields on junk bonds rated CCC have risen steadily since March, when the US and Israel were launching their first strikes on Iran.
But they’ve spiked aggressively since September as a selloff in Treasuries boosted benchmark borrowing costs, and investors started to become more nervous about risks associated with the mountain of AI-related financing to be sold, including by companies already groaning under heavy debtloads.
In lockstep with rising stress in junk bonds, the deeply distressed tail of the leveraged loan universe has grown to levels not seen since the beginning of the pandemic.
The volume of loans trading below 60 cents on the dollar, signalling deep distress, in September was at its highest since March 2020, according to a research note from JPMorgan Chase & Co. The amount of loans trading at or below 80 cents on the dollar surged almost 90% in the past 12 months, the strategists wrote.
A significant cohort of CCC-ranked borrowers already carry heavy leverage and are more susceptible to rate increases as the cost to service their debt swells.
For some of these companies, restructuring is a likely outcome, according to Robert Cohen, director of corporate credit at DoubleLine Capital, which oversees more than US$93bil in assets.
There are “hopeless CCCs, regardless of the macro, that are going to get restructured,” Cohen said in an interview.
The possibility of a liability management exercise, a process that can often leave creditors and borrowers at loggerheads, are among the difficulties with those investments, he said.
But he sees those as credit-specific issues. “I do not believe the stress in CCCs is indicative of a credit cycle,” Cohen said.
It is unusual for CCC spreads to blow out so much while the rest of the credit market remains generally stable. The differential between CCC and the higher-rated tier of BB spreads is the widest its been since the pandemic.
Distressed companies including Quest Software or CDK Global are staring at technological obsolescence for example, as AI advancements could threaten their business models. Cornerstone Building Brands Inc, whose bond due in August 2029 was quoted at about 37 cents on the dollar last Friday, is grappling with a debt restructuring and depressed earnings.
Other companies with bonds or loans trading at less than 60 cents on the dollar include Altice International and broadband provider Brightspeed.
Liberty Communications of Puerto Rico LLC was also slashed to CCC by S&P Global Ratings as it faces a restructuring or default on about US$1.2bil in bonds due next October, the credit grader wrote in a note last Wednesday.
Like software, cable and telecom companies face pressure from new technology. Elon Musk’s Starlink Inc, for example, is competing for broadband customers, while cable-television providers are bleeding viewers to streaming services.
“We’re seeing pockets of stress across industries,” said Jared Parker, co-head of global opportunities at Oaktree, which built its business around distressed investing.
“The sea change in rates that started in 2022 has hit the housing sector very hard, and weakness there has broader knock-on effects across the economy,” he said.
Oaktree, which manages more than US$160bil in credit assets, is being selective in how it is taking advantage of beaten down credits, he said.
More broadly, investors, including those who typically invest in high-grade borrowers, have fled to higher-rated portions of the junk-debt market.
But others are starting to look for opportunities within the most beaten-down pockets of the market, even in software.
Businesses with short-dated debt, high customer retention and revenue growing at 5% or 6% are among those worth looking at, Steven Tananbaum, chief investment officer at GoldenTree Asset Management said at a Morgan Stanley Credit Symposium.
He noted that some of these “you can buy at 70% discounts to what these companies were sold at a few years ago”. — Bloomberg
