Heady days of record low junk bond yields over for now

NEW YORK, April 20 (IFR) - The heady days of junk bond deals pricing with record low coupons in the 5% region are over and a new pricing floor 100 basis points wider than that has developed, according to bankers.

That's after a slew of lower-yielding deals performed worse than companies with lower ratings in recent weeks.

In an unexpected move, the BB sub-index of the Citigroup high yield market index has widened out 33bp from its tightest yields in mid-March, more than the lower rated single-Bs, which only widened 25bp.

"This is very unusual," said Michael Anderson, chief high-yield bond strategist at Citigroup. "You would expect that as the market traded off, the single Bs would be weaker than double-Bs because they are higher beta instruments."

The reason for the move is that ultra-low yields on some recently-priced junk bonds have made high yield far more sensitive to rising Treasury rates, which are typically more of an issue for investment grade bonds.

"In the past, when coupons were in the 9%-10% range, high yield never had to worry about Treasury rates rising," said Jim Casey, co-head of global debt capital markets at JP Morgan. "But a whole new element of rate-induced volatility has been introduced into high yield funds that own bonds with a 5% handle."

The under-performance of the double-B category can be traced back to mid-March, when Treasury yields backed up, taking the 10-year Treasury out of its then four-month 1.8%-2.10% range to as high as 2.39%.

Double-B rated Crown Castle was forced to pull a $1 billion B1/B- rated senior deal in early April when investors baulked at its quest for a coupon in the 5.50%-5.75% range.

Although 10-year Treasury yields have since come back down to around the 2% level, high-yield investors are still vetoing almost everything below 6%.

"Just because Treasury yields have come back down, doesn't necessarily mean we are back to doing 5% deals," said Peter Toal, head of leveraged capital markets at Barclays. "Volatility has increased and the market saw what happened to very tightly priced deals when Treasuries backed up."

Constellation Brands would have been a prime candidate for a low to mid 5% coupon in February, say bankers, but had to price its $600 million Ba1/BB+ rated senior unsecured deal at 6% last week.

"Constellation is a good example of the market redefining the floor at 6%", said one banker.

The return to the low 5% range is not likely until Treasuries have been calm for a series of months, say some.

"That's because investors got burned with those 5.00% coupon bonds," said one market participant. "And that will be in their memory for a while."

Citigroup's Anderson doesn't expect to see deals priced in the low to mid 5% range until Treasuries show several months of calm. However, he agrees with those who say a top double-B credit could pierce the new 6% floor if there are several weeks of low Treasury volatility.

But for now, "there is too much volatility out there and people don't have a good enough sense of where Treasuries are going at the moment," said Anderson.

"If things were to calm down and stay in this 2% range on the 10-year for a while, then you could see people getting comfortable in the high five coupon region. But it could take into the summer or the Fall."

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