Nature of new high yield issuance points to continued rally
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While fund inflows have been partially responsible for the issuance, the total volume issuance has not been fully funded by new funds. This year around 60% of the new issues have been refinancings, primarily driven by corporate issuers taking advantage of the low interest rate environment. Much of the refinancing was overdue last year, but market conditions at the time forced issuers to delay refinancing to avoid locking in unfavorable yields.
The resulting increased issuance volume, originally driven by the refinancing, has lowered the debt yields significantly and further enhanced market conditions to favor issuers. In turn, issuers continue tapping the market opportunistically as they chase and aim to lock historically low rates. At the same time, decreasing rates have caused the debt prices (face value) to rally, fueling the Q3 rally of the USD debt capital markets and motivating investors to continue injecting liquidity into the market.
Riskier issuance points to prolonged rally
Early October saw three weeks of fund out-flows, reflecting investors’ skepticism of a prolonged rally, though recent issuance has shown the market riskier structures that have priced at very favorable yields for the issuers.
The graph below shows that issuances rated single B or lower amounted to 58% of all issuances year-to-date. While this value is similar to that of previous years, the proportion of CCC deals is much higher, implying riskier issuance as investors move down the ratings searching for additional yield. Also noteworthy are several recent Pay-In-Kind, or PIK, bond issuances to fund dividends, such as IDQ, EMS, Petco, Jo-Ann Stores and very recently Dematic Holdings. Currently there is at least one more PIK deal down the pipeline. PIK bonds give the issuer the option to either pay a cash coupon or “pay in kind,” at a slightly higher rate (generally 75bps higher), which means that the principal of the bond is increased by the amount of the PIK interest. Each subsequent issuance has come to market with more aggressive non call periods that under normal market conditions would be unacceptable for investors, especially given these were all CCC+ rated issuances.
The increasing recapitalization transactions, large share of lower rated deals and riskier structures pricing at exceptionally low yields signal that the investors are still willing to buy and fund the present rally. The high yield bond ETFs such as iBoxx $ High Yield Corporate Bond Fund (HYG) and SPDR Barclays Capital High Yield Bond ETF (JNK) will continue to benefit if the high yield market maintains its course.