Tuesday, April 28, 2009

even though such risks are much reduced following government interventions at banks

TO BE NOTED: From the FT:

High-yield bonds feel thaw

By Aline van Duyn and Nicole Bullock

Published: April 27 2009 19:24 | Last updated: April 27 2009 19:24

The US high-yield market is finally starting to show signs of thawing.

Even as default rates soars to historic highs, investors have increased the amount of money invested in the market for risky corporate bonds, and yields in the high-yield or junk bond market have fallen sharply. It is a further sign of improving sentiment in credit markets and follows an earlier surge in issuance in the investment grade market.

Investments most easily tracked are those by mutual fund investors. Since December 2008 more than $8bn has been invested in the high-yield market by US retail investors, according to Goldman Sachs research.

Goldman Sachs analysts said: “On the one hand, the high yield cash market has outperformed to such a degree that it is one of the few asset classes to post a positive return year-to-date.

“On the other hand, the default rate has surged to an annualised rate of 14 per cent year-to-date, and March was among the worst months for default in the past 20 years. What gives?”

Analysts and investors say that, in spite of the overall reductions in yields in the junk bond market to levels last seen since October, there remain clear differences in the availability of credit. Specifically, the riskiest companies – those with ratings in the triple C range – continue to have trouble raising new money or completing debt exchanges.

Greg Hopper, portfolio manager at Artio Global Investors says: “The high-yield market was very cheaply priced at the end of last year, even if one assumed that we were going to have an Armageddon-like default rate.

“A lot of investors recognised that through the first few months of the year.”

Initially investors targeted beaten down bonds in the secondary market, but over the last month, there has been enough liquidity for bankers to start testing the appetite for new issuance, albeit for the strongest companies. HCA and Crown Castle have both sold more than $1bn in new debt.

Mr Hopper says: “Where there had been concern about companies being able to refinance, that concern is starting to fall away, beginning with the best quality companies.”

But investors should beware of buying junk indiscriminately, especially since the market has rallied. Like many other credit markets, high-yield is a picker’s market now. Martin Fridson, head of Fridson Investment Advisors, says many institutions have been wary of plunging into the high-yield market, even as retail investors have been buying into it, because of the risks that the rally might run out of steam.

Specifically, he says investors are still concerned about the potential for a renewed crisis among financial institutions, even though such risks are much reduced following government interventions at banks.

He says: “It is possible that the worst is over, but as long as the economy is still not improving, there remains a risk of a severe relapse of the financial system”.

Whether the rally is sustainable remains up for debate given the tightness of lending in general throughout the world and expectations of potentially the highest rate of corporate defaults.

Mr Hopper highlights three concerns: the health of the banking system, the threat that new issuance returns too strongly and floods the market or a disorganised bankruptcy of General Motors, which is the process of trying to restructure $27bn in unsecured junk debt.

He says: “If GM comes through this without having to go through Chapter 11 or if it goes through some sort of more orderly Chapter 11 that would provide further positive impetus to the high-yield market.

“If, on the other hand, the efforts to reorganise the auto industry unravel that could be a risk to the market. But it is more of a risk to the auto sector in particular than the whole high-yield universe.”

Even though issuance of high-yield bonds in April – at $7bn so far – looks set to be the highest since July of last year, credit is not yet available for the riskiest companies. Moreover European high yield markets have seen only one issue since June 2007.

Greg Peters, head of global fixed income research at Morgan Stanley, says: “We caution investors who correlate a thawing high yield new-issue market with the end of this credit crunch, as the financing markets are still fragile for levered corporates.”

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