* Short selling in US high yield companies picks up
* Rising rates will take a while to feed through
* Default rates are unlikely to spike immediately
By Natalie Harrison
LONDON, July 26 (IFR) - Short sellers may be targeting US
high yield issuers in the equity market, but credit investors
remain confident that most leveraged companies will be able to
withstand an inevitable rise in funding costs and that defaults
will remain low.
Demand to borrow shares of the 92 publicly traded
constituent companies of the CDX North American High Yield index
has risen to 5.8% of shares from an 18-month low of 5.5% at the
end of June, according to data from index provider Markit.
The increase follows weeks of volatility since late May when
Federal Reserve Chairman Ben Bernanke signalled the central bank
would reduce its bond buying programme - sending the high yield
credit index to a 2013 high of 478bp, and 10-year Treasury
yields surging more than 70bp to over 2.7%.
"The increase in short selling may not be that spectacular,
but it does indicate that people are beginning to question the
impact on equity if the cost of financing for heavily indebted
companies begins to rise," said Simon Colvin, an analyst at
AK Steel tops the most borrowed list, with 24.7% of its
shares out on loan, while the cost of insuring its debt against
default is the fourth highest in the Markit CDX North American
High Yield index, according to Markit.
Competitor United States Steel Corporation also stands out,
with 20% of its shares on loan as the industry continues to
suffer from weak demand, while retailer RadioShack is second on
the list with 22% of shares on loan.
That follows a surge in demand ahead of its earnings this
week, which revealed worsening losses as its struggles against
competition from online retailers, sending its 6.75% May 2019
bonds down USD4 to USD72 and its five-year CDS 90bp wider to
CREDIT VS EQUITY
But some market participants say that the nascent pick-up in
short selling may not necessarily be a bad thing, especially if
the economic outlook is improving - a factor that the Fed says
will drive its QE decision making process.
The CDX North American High Yield index has certainly
recovered, trading around 378bp on Friday.
Chetan Modi, managing director at Moody's, said there were
other variables to consider other than rising interest rates
that could impact equity prices.
"If rates go up, yes the cost of funding will start to rise,
but that will not impact the cost of fixed rate debt that is
already in place," said Modi.
"It is mainly an issue for corporates when they have to go
out to the market to refinance again."
US high yield volumes so far this year total USD246bn versus
USD376bn for the whole of 2012, according to Thomson Reuters
Hermes Fund Managers, for example, is upbeat on US Steel's
outlook from a credit perspective.
"We would actually take it as a positive that 20% of US Steel
shares are out on loan. That means that bad news is being priced
in," said Fraser Lundie, co-Head Hermes Credit.
"US Steel is in a very tough sector and it has had to behave
defensively by cutting capex and cancelling future M&A plans. It
has also undergone balance sheet repair, by paying down and
terming out debt to protect its ratings and ensuring it has
access to capital markets."
US Steel, rated Ba3/BB-/BB-, cut its dividend in late 2008,
and has kept it low since then. It reported a first quarter loss
at the end of April, and said it expected operating results to
deteriorate further in the second quarter.
Its second quarter results will be released on July 30.
NO SPIKE IN DEFAULTS
Neither will defaults likely spike as a result of rising
funding costs, both analysts and investors say, as companies
have taken advantage of low rates to term out debt.
Global speculative-grade defaults rose marginally to 2.8% in
the second quarter, but remain well below the historical average
of around 5% and the spike in defaults seen in 2009 to around
12%, according to Moody's data.
"The fact that default rates have remained so low in one of
the worst recessions in our lifetime doesn't suggest that we
will see an immediate spike," said Modi.
"If interest costs do rise, this will be spread out over a
period of time, and so there will be less immediate impact on
US Steel, for example, refinanced existing debt in March
with a USD275m 8NC4 senior note that was upsized from USD250m
and paid a 6.875% coupon.
"Rising rates have not been an unknown risk. CEOs are not
stupid, and have been clearly working with banks to get their
capital structures in better shape," said Lundie.