Headlong dash for "junk" raises alarm
LONDON (Reuters) - In the seemingly obsessive search for the next bubble in global markets - an understandable if hyper-sensitised reaction to missing the last one - speculative credit remains a prime suspect.
It's been boom time again this year for what used to be known as "junk bonds", but which now go by the more polite moniker of high-yield, speculative-grade debt - much of which is corporate borrowing.
According to Lipper estimates, high-yield bond funds of all hues have seen inflows of some $45 billion (28 billion pounds) in the year to September, higher than any nine-month period since 2005 even if still shy of 2010's full-year inflows of $70 billion. Some $33 billion of that was into U.S. junk bonds alone.
New bond sales are booming and U.S. issuance last month alone at a record of $34 billion, taking advantage of the demand and falling borrowing costs. Yields on catch-all U.S. junk indices hit a record low of 6.15 percent in September - almost half where they were at the end of last year or a quarter at the peak of the 2008 credit shock.
And trend is global, in European high-yields as well in emerging market corporate bonds. New funds targeting debt issued by emerging companies have helped push outstanding issuance past $1 trillion, up 10-fold since 2000 and now rivalling the U.S. market, and new bond sales at a record $227 billion for the first nine months of 2012.
So is this dash for yield well considered against all the inherent default risks attached to any speculative-grade issue and at a time of a slowing world economy?
Despite virtually all yields looking "high" in an official zero interest rate world, are high-risk corporate bonds a sure bet at a time when many people are bracing for another 5-10 year funk in global economic activity?
Diane Vazza, head of Standard & Poor's Global Fixed Income Research, has her doubts about the U.S. market at least.
"Far from being the result of increased creditworthiness by corporate borrowers, this falloff in yield is more a result of investors' search for return among available investment avenues," she said in a report this week. "This hunt for yield is also happening in Europe."
Vazza said investors need to very careful with the wide range of risks in this territory. While default rates for firms rated BB, just below investment grade, remain historically low, default rates in lower credits are rising and the trailing 12-month default rate for 'CCC/C' category has risen through 2012 to as high as 27.2 percent in August.
"At this point in the high-yield credit cycle investing in the broad market for the lowest-rated debt has become a very risky strategy," she said.
WHY THE DASH FOR 'JUNK'?
Global investors are hunkering down for several more years of slow, sub-par world growth but they also are being herded out of traditional safe-havens of cash and "risk-free" western government debt by deteriorating sovereign credit ratings and central bank money-printing that has deliberately engineered negative real and even nominal yields.
And even though extraordinary central bank action may well mitigate the risks of sudden shocks and other tail risks, the still-lousy growth prognosis is keeping many wary of equity and commodities, at least beyond blue-chips with hefty dividends.
And for all the weariness of debt, defaults and credit indigestion of the past five years - one of the consensus trades has been to switch sovereign risk for corporate risk, with junk and emerging credits joining the party too as the volumes of investment chasing the sector spills over.
The juicy yields in a low interest rate world, perceived better balance sheets that hobbled governments, historically low default rates in some areas, and international contracts in world currencies are all cited as a draw in uncertain times.
The avoidance of highly uncertain sovereign bond markets, especially in Europe, has been the tipping point for many funds who even now would still prefer a high-grade Spanish corporate bond than debt issued by the government because of uncertainty over the euro crisis and demands by to avoid euro sovereigns.
But as the corporate sector leverages up worldwide - in part because direct bank financing has become more difficult --there are considerable risks attached.
For some, the market's time in the sun could well continue for a bit longer and into early next year. But the sheer scale of new issuance in the expanding high-yield universe is cause real worries about refinancing further out.
David Spegel, ING's head of emerging market debt research at ING in New York, is fretting about so-called rollover risks into 2014 in particular.
A swathe of credit rating downgrades for European companies this year means many fund managers who bought high-grade assets, have now found themselves holding sub-investment grade paper.
Spegel calculates in a note this week that $47 billion of "junk" rated European paper will find itself up for refinancing in the first half of next year, more than double the levels that were rolled over in the first half of 2012.
And it gets worse, as S&P's Spanish sovereign downgrade this week to just one notch above junk highlighted. The big fear is that if Spain and Italy tumble into the junk-rated category their corporate sector may well follow suit.
ING estimates over $100 billion in Spanish and Italian BBB rated corporate bonds are due next year. If these slip into speculative grade, it would triple the amount of high-yield paper that needs refinancing in the first six months of 2013.
The picture is slightly less dire in the United States next year but it worsens in 2014, when high-yield debt redemptions total $121 billion, or a 60 percent jump from 2012 levels.
"Should risk-appetite sour…refunding may prove problematic for many global speculative grade corporates, in which case we could look forward to significantly higher global default rates as soon as 2014," Spegel told clients.
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