As junk bond outflows soar, market stays calm

IFR 2175 18 March to 24 March 2017 By Natalie Harrison, Shankar Ramakrishnan, Davide Scigliuzzo

The US high-yield bond market has suffered a setback as investors yanked billions of dollars from junk funds, but analysts say the asset class remains in fairly decent health and that a larger price correction is not necessarily on the cards.

The buyside withdrew US$5.683bn from US high-yield funds during the week ended March 15 - the biggest since August 2014, according to Lipper data - amid nerves about valuations, the pace of Fed rate hikes and heavy supply.

“Going into the outflow surge, we had been seeing a more hawkish stance from the Fed, and investors at the same time had been getting increasingly worried about valuations after such a strong rally over the last 12 months,” said Stephen Caprio, credit strategist at UBS.

“Investors still seem to be okay with high-yield as an asset class, but there is a little bit of ‘how far can we really take this?’ in terms of valuation.”

Average high-yield bond spreads widened in the run-up to the Federal Reserve rate hike on Wednesday - its second in three months - touching a peak of Treasuries plus 405bp on Tuesday, the highest level since January 23, according to Bank of America Merrill Lynch data.

But by Thursday evening, spreads were back at plus 388bp and some investor cash had started to move back into funds.

Roughly US$654m and US$589m of cash had poured back into high-yield bond ETFs on Wednesday and Thursday respectively, Caprio said, suggesting that technicals may not deteriorate further in the very near term.

HOLDING UP

The blip, if that is what the latest outflow was, comes after a stellar rally for high-yield that saw spreads get to within 20bp of post-crisis lows in June 2014. Back then, spreads narrowed as far as 335bp over Treasuries, BAML data show.

The pick-up in volatility led to some turbulence in the primary market in recent days.

Chemical company Rain Carbon rejigged its planned junk bond offering, cutting its size, increasing its seniority, and widening the yield to 7.25% area from low 6% initially, sources familiar with the matter told IFR.

Some issuers - such as Foresight Energy - also moved out price talk from whisper levels, but the big takeaway for bankers was that the secondary market was fairly resilient. Nearly all of the week’s new issues were trading up above reoffer by Friday.

T-Mobile, which raised US$1.5bn from a three-part trade to refinance debt, was up across the board, and a couple of issuers also managed to increase the size of their deals.

First Quantum Minerals upped its two-part offering to US$2.2bn from US$1.6bn, pricing a US$1.1bn six-year non-call 2.5 at par to yield 7.25% - slightly wide of 7% area price talk - and a US$1.1bn eight-year non-call three at par to yield 7.5%, also slightly wide of price talk (see Emerging Markets for more).

Information technology research and advisory company Gartner also increased the size of its trade - to US$800m from US$600m - and priced the eight-year non-call three deal at par to yield 5.125%, just inside talk of 5.25% area.

In all, the market had priced US$6.35bn of deals by Thursday, with at least four more due to get over the line on Friday from KCA Deutag, Kraton Polymers, Rain Carbon and GasLog.

But even with those last deals to get done, supply was well below the more than US$17bn that came to market the week before as issuers crammed in deals ahead of the Fed hike and fatigue started to set in.

That slower pace was certainly a supporting factor for technicals.

STILL RICH

Valuations, as well as oil prices that have weakened of late as the Saudis have ramped up production, are likely to remain an area of some concern.

A survey of investors, taken by Bank of America Merrill Lynch and published on Monday, showed that high-yield investors had moved underweight for the first time since December 2008.

A net 85% of investors now find spreads overvalued compared with 67% in January, the highest level since April 2007.

For others, the bigger worry is moving in and out of trading positions.

“What concerns me most is market liquidity. It’s not very good, and if weakness was to persist, this could become more of an issue,” said one high-yield investor.

“Flows come and go, but the market can usually absorb it pretty well.”