By Sam Goldfarb
This article is being republished as part of our daily
reproduction of WSJ.com articles that also appeared in the U.S.
print edition of The Wall Street Journal (April 29, 2020).
A rally in corporate debt is enabling riskier companies to raise
much-needed cash while fueling debate over whether investors have
grown overly optimistic about the economy.
From April 13 through Friday, companies such as Ford Motor Co.,
AMC Entertainment Holdings Inc. and SeaWorld Entertainment Inc.
issued a combined $28 billion of speculative-grade bonds, the
fourth-largest two-week total on record, according to LCD, a unit
of S&P Global Market Intelligence.
The surge in issuance follows an even bigger boom in new sales
of investment-grade bonds, as businesses of all stripes try to
stock up on funds to weather a period in which many can expect
little to no incoming cash flow. Bond sales have continued despite
volatility in oil prices, with investors largely separating the
problems of energy companies from those in other sectors.
Speculative-grade companies -- which tend to have large debt
loads, challenged business operations or both -- had gone most of
March without issuing new debt, after investors dumped their bonds
and potential borrowing costs skyrocketed.
On Feb. 18, the average extra yield, or spread, investors
demanded to hold speculative-grade bonds over U.S. Treasurys was
just 3.41 percentage points, according to Bloomberg Barclays data.
By March 23, it had climbed to 11.0 percentage points. But Monday,
it was back down to 7.74 percentage points -- still relatively
high, but low enough that large numbers of companies can borrow in
the market, especially if they back their bonds with
collateral.
The yield on the benchmark 10-year U.S. Treasury note settled at
0.610%, according to Tradeweb, compared with 0.655% Monday. Yields
fall when bond prices rise.
Along with other assets like stocks, high-yield bonds have been
boosted by government and central bank policies. Those include the
Federal Reserve's promise to buy investment-grade corporate bonds
and even some lower-rated bonds, provided they were only recently
downgraded.
Investors' analysis of history has also helped. Over the past
three decades, high-yield bond investors have been able to generate
some of their best returns in the months after large selloffs
pushed spreads to about 9 percentage points.
The lesson from that is "you don't get this opportunity every
year, and when you do you've got to jump on it," said Scott
Roberts, head of high yield at Invesco Fixed Income.
Improved demand for speculative-grade bonds has already helped
some companies.
Prices for Ford bonds collapsed last month when the company shut
down car production. On March 24, the company's 7.45% unsecured
bonds due in 2031 traded as low as 62.25 cents on the dollar,
according to MarketAxess, translating to a yield above 14%. S&P
Global Ratings downgraded the company's credit rating to below
investment grade the next day.
Already wrestling with slowing sales before the pandemic, Ford
has estimated it could burn through around $5 billion a month
before it gradually restarts production in the second quarter.
The bonds, though, jumped to nearly 90 cents on April 9, when
the Fed said it would buy recently downgraded bonds. A week later,
Ford issued $8 billion of unsecured bonds, the largest
speculative-grade bond sale on record, according to LCD. Its new
10-year bonds came with an interest rate below 10%.
The recent rally in high-yield bonds is part of a broader trend
that has lifted the S&P 500 by about 28% since its March lows.
As with stocks, however, investors are questioning the durability
of the move.
One cause for concern is an unusually large disconnect between
what the market is implying about how many companies will default
over the next nine to 12 months and what analysts at ratings firms
and Wall Street banks are predicting.
According to one model developed by Marty Fridson, the chief
investment officer at Lehmann Livian Fridson Advisors LLC and a
longtime high-yield bond analyst, the market is currently pricing
in a 12-month default rate of 8.1%. A different model produced by
research firm CreditSights put the market-implied default rate on
Friday at 7.4% over the next nine months.
By contrast, Moody's Investors Service has forecast a trailing
12-month default rate of 11.8% by the end of the year and 13.1% by
the end of next March. Analysts at Goldman Sachs Group Inc. have
similarly forecast a 12-month default rate of 13% by the end of
this year.
With social and business activity severely restricted across the
country, there is little debate about the near-term hit to the U.S.
economy. Investors, though, have tended toward optimism about how
quickly the economy can recover, with markets consistently rallying
on signs that the spread of the virus is slowing or that potential
drug treatments are working.
Many economists -- and, for that matter, epidemiologists -- have
been more pessimistic. In their view, the threat from the virus
could linger into next year, continuing to depress economic
activity and causing bankruptcies and job losses that will further
drag on growth.
"My sense is the market is attaching a higher probability to a
V-shaped recovery than I would or most economists would at this
point," said Mark Zandi, chief economist at Moody's Analytics,
which produced the economic forecasts underlying the default
forecast of its sister ratings firm.
One wild card could be the market's ability to help create its
own reality. The stronger the high-yield market is, the more likely
it is that struggling companies such as movie-theater operator AMC
will be able to obtain rescue financing, holding down the default
rate at least over the near-term horizon.
Still, extending loans to businesses that might otherwise run
out of cash isn't without risk, since adding debt to companies
could lead to deeper losses for bondholders if those businesses
ultimately file for bankruptcy anyway.
"We don't know if we are prolonging the inevitable and impairing
recoveries at a junior level, or whether we're providing the
Band-Aid to actually get the company through to sustainability,"
said Geof Marshall, head of fixed income at Signature Global Asset
Management, a division of CI Investments.
Write to Sam Goldfarb at sam.goldfarb@wsj.com
(END) Dow Jones Newswires
April 29, 2020 02:47 ET (06:47 GMT)
Copyright (c) 2020 Dow Jones & Company, Inc.
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