Market conviction dried up for new issuance
There are three possible reasons why high yield bond markets fell off a cliff last week.
Interest rate drives the bond market
The first possible reason—interest rate drives the bond market. When the market interest rates rise, new issuance offered in the market provides higher returns compared to the existing bonds. This means that the older bonds are worth less, and their market price falls.
Last week’s case: When the market interest rates drop, new bonds may be issued into the market with lower coupon than older bonds. This means that the older bonds are worth more and their market price goes up.
Credit rating is an essential component to drive the issue
The second possible reason—credit rating is an essential component to drive the issue. A credit rating agency based on the issuer’s current financial status may decide to lower the credit rating. If the credit rating declines, then the bond’s market price may fall and vice-versa.
Suppliers didn’t find buyers
The third possible reason—suppliers didn’t find buyers. Sometimes issuers find it difficult to entice the buyers with the bond offering terms. In that scenario it takes long for an issuer to sell the bond at the price they want.
A credit spread is the risk premium over the Treasuries. Credit spreads in the high yield bonds (JNK) increased in the market’s perception of higher credit risk across industries. The U.S. ten-year Treasury yield rose by 13 basis points, while the BB index yield rose by 6 basis points, leaving ten-year BB spread to fell over by 7 basis points.
As observed in the chart above, the market activity in high yield bonds (JNK) declined dramatically last week. Issuance reached $5.8 billion—a completely reversed trend from the previous week’s issuance. In the previous week, the high yield bonds broke the past 25 weeks’ record at $11.7 billion issuance.
In combination to the decline in the dollar value of the issuance, the number of issues also declined—there were 15 issuers to carry out the investor’s demand for the high yield bond market. The year-to-date issuance was $59.0 billion—23% below the last year’s year-to-date issuance of $72.5 billion.
New issue yields
Of the total 15 deals, a large number of deals were split between BB and single B category. There were only two CCC rated bonds. BB and single B rated bonds are non-investment speculative grade bonds, whereas CCC rated bonds are extremely speculative with a substantial amount of risk.
Average yield declined for the newly issued BB rated bonds, to 4.80% from 4.85% in the previous week. Single B rated yields declined to 6.24% from 6.78% in the previous week.
Investors who wish to tap the high yield bond market can learn more about the iSharesiBoxx $ High Yield Corporate Bond ETF (HYG) and SPDR Barclays Capital High Yield Bond ETF (JNK). Both the ETFs represent nearly 80% of the high yield bond ETF market, with top holdings in Sprint Corporation (S) and Hospital Corporation of America (HCA).
Sprint Corporation (S) is a U.S. telecommunications holding company, while Hospital Corporation of America (HCA) is an American non-profit health care operator.
© 2013 Market Realist, Inc.
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