High-yield sell-off seen overdone

Fri Aug 8, 2014 12:10pm EDT

NEW YORK, Aug 8 (IFR) - The US high-yield market may have suffered its biggest outflows on record over the past week, but strategists, bankers and investors say the move is overdone and completely out of line with what is occurring in other fixed income markets.

The outflows, which reached US$7.1bn last week and US$12.604bn over the past month, according to Lipper data, have had a brutal impact on the market.

Banks have pulled deals for the first time in months, while those that have priced bonds have paid double-digit coupons. Spreads, meanwhile, have widened by 90bp, with the yield-to-worst on the Barclays high-yield index now at 5.73%.

Market players are now trying to figure out if there is worse to come or if more stable conditions will return.

Dislocation in the credit market - with relative calm in the investment-grade sector, and even European subordinated financial paper by comparison, despite the bailout of Portuguese bank BES - does not make sense, some say, if the culprits for the high-yield sell-off are geopolitical or rate rise fears.

"The high yield market experienced nothing more than a short-term correction and some profit-taking, and we wouldn't be surprised to see a fairly quick rebound," said Dan Doyle, a high-yield portfolio manager at Neuberger Berman.

"Why? Generally speaking, high yield performance is driven by defaults and economic growth. We're hard pressed to see a scenario where defaults significantly increase over the next 18-24 months."

Moody's expects defaults to remain in the 2% to 2.5% range over the next year.

RUN BY ETFS

Most reason that high-yield has been hit so hard because of the concentration of short-term high-yield paper held by exchange traded funds and mutual funds. The run on the market by retail investors follows gains of 5.7% in the six months to end of June, according to Bank of America Merrill Lynch data.

"There's a rotation trade going on," said one senior leveraged finance banker. "People have been in high-yield for three to four years and done pretty well out of it so they are taking some chips off the table, but I don't know where they are putting that cash - it's certainly not into equities."

Deutsche Bank strategists Oleg Melentyev and Daniel Sorid said the outflows also have to be put in perspective with the huge growth in the high-yield market. They point to eight previous episodes of outflows since 2009 which have lasted 21 days on average, citing EPFR data.

Aug 4 marked the 20th consecutive trading session of negative outflows in global high-yield funds, they said.

An outflow of US$3.7bn on August 1 was lower than a 1.1% withdrawal on August 9 2011 following the downgrade of US sovereign debt during the debt ceiling debacle, or 1.14% on May 10 2010 - the start of a three-year long European sovereign crisis, the Deutsche Bank strategists said.

Others point to far frothier conditions in previous cycles - and said calm will be restored.

"Spreads have spent over 13 years of their history at levels tighter than we are now," said Phil Milburn, co-manager of the Kames high-yield bond fund.

He called talk of a bubble in high-yield "absolute nonsense."

"Provided default rates do not meaningfully increase, and one's time frame is long enough to look through a few months of mark-to-market volatility, investors should still earn mid-single digit returns from high yield," Milburn said.

STANDSTILL

Even so, the adjustment has been painful, and the primary market now looks set to grind to a halt until after Labor Day.

The sell-side is nervous, as they have underwritten large M&A transactions on terms that could result in them losing money if conditions deteriorate a lot more.

For now, they are sticking to the mantra that investors still have plenty of cash and that there is no forced selling.

Income from coupons alone comes to about US$7bn a month, taking into account the roughly US$1.2trn size of the US high-yield market and average high-yield coupon of 7.03%, according to the Barclays index.

Thin liquidity in secondary, made worse by low bank inventories, has made it tough for investors to buy bargains.

Billion-plus bond deals pushed back this week for the buyout of Safeway and Jupiter Resources by Cerberus and Apollo respectively will no doubt pay the price for the volatility when their deals are launched in September.

But overall, the M&A acquisition pipeline is fairly manageable after a robust year for high-yield volumes that have reached US$201bn so far this year, according to IFR data.

There's roughly US$30bn of M&A bond supply earmarked from now until the rest of the year. Around US$12bn of that is for Valeant's planned takeover for Allergan - a deal that is still far from certain.

Other big deals M&A deals pegged for later this year include Zebra Technologies, Dollar Tree and Scientific Games - high-quality credits, most likely to be rated Double B, bankers say.

And though flex and cap rate terms may change to reflect the market's setback, appetite to commit new financing hasn't waned.

"This is a good time to be underwriting deals as long as you believe that outflows will slow, that there is nothing fundamentally wrong with credit, and that rates will rise gradually," said another senior leveraged finance banker.

"I'd rather be underwriting deals at 7.5% than 6.5%." (Reporting by Natalie Harrison; Additional reporting by IFR's Mariana Santibanez and Robert Smith and TRLPC's Michelle Sierra; Editing by Shankar Ramakrishnan)

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