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Fridson on High Yield: What if the Election Ends with no Winner?

How bad was the high-yield market’s pre-election sell-off?

From Oct. 25 from Nov. 4 the option-adjusted spread (OAS) on the BofA Merrill Lynch US High Yield Index widened by 60 bps, from 460 to 520. That ranks just within the first decile of eight-day widenings since the inception of OAS on Dec. 31, 2016. The 60 bps swing also ranks within the top 10% of all moves, wider or narrower.

Note, however, many eight-day widenings during the Global Financial Crisis were far bigger. In all, there were 22 eight-day widenings of 200 bps or more during 2008’s chaos, topped by a move of 438 bps. The biggest eight-day tightening was negative 336 bps, which occurred in the eight-day span ending Jan. 7, 2009.

By labeling the recent move the “pre-election” sell-off we imply—intentionally so—that the tightening presidential race produced a risk-off response. The most widespread interpretation is that Hillary Clinton, who until recently held a commanding lead in the polls, is considered the more predictable of the two main candidates. The nature of a Donald Trump administration is thought to be more uncertain.

Certainly, one could dispute that explanation. As always, other events occurred that could have been responsible for the high-yield downturn. Most prominently, crude oil prices fell by 12% between Oct. 25 and Nov. 4, as measured by the Generic 1st Crude Oil, West Texas Intermediate contract. Over the past two years, to be sure, major swings in energy prices have triggered outsized moves in the high-yield market’s Energy component.

Those industry-specific jumps have resulted in substantial moves in the high-yield index as a whole. From Oct. 25 to Nov. 4, however, the BofA Merrill Lynch US High Yield Energy Index widened almost exactly in line with the BAML High Yield Index as a whole (62 bps and 60 bps, respectively). Based on the fact that Energy essentially performed no worse than the rest of the high-yield universe, we reject the hypothesis that falling crude prices precipitated the sell-off in the last few days before the election.

There may be more to the story, though, than apprehensiveness over a Trump administration. Another possibility is that the market is attributing some probability to a hung election. In the near term, that outcome would present major uncertainty in its own right.

What if the election ends with no winner?
Prior to early November, as far as I have been able to establish, there was little or no discussion of the possibility of the winner of the presidential election remaining unresolved beyond early tomorrow morning. On Nov. 6, though, Fox News discussed the mathematically possible—if statistically improbable—outcome of an exact tie in the Electoral College, at 269–269.

Barring the deadlock being broken by a faithless elector, the decision would then be thrown to the House of Representatives. Perhaps a more easily imaginable scenario is a replay of the 2000 election, when disputed ballots in one state kept determination of the winner on hold for over a month.

Between Election Day, Nov. 7, 2000 and Dec. 12, 2000, when the Supreme Court voted 5-4 to leave intact a Florida vote count that narrowly awarded the state, and consequently the election, to George W. Bush, the BAML High Yield Index’s OAS widened by 119 bps, from 775 to 894. In-between, the spread reached a maximum of 913 bps on Dec. 7.

Was the Nov. 7–Dec. 12 widening, which corresponded to a –2.26% (–21.23% annualized) total return, a hung-election phenomenon that could serve as a guide of what to expect if today’s vote proves inconclusive for the time being? To be sure, the high-yield spread was already on the rise in November 2000. It had ended 1999 at 476 bps, meaning it was up by 299 bps in the year to date on Election Day.

The day before Election Day Bloomberg BusinessWeek reported that the default rate stood at 3.83%, up from 1% in 1997. November 2000 was also noteworthy for precipitous drops in Technology and Telecom equities, with some stocks losing about half their value.

The chart below shows, however, that November’s spread-widening represented a spike, a conspicuous discontinuity in the steady rise in the spread that reached its apogee in late 2002. In November 2000 the BAML index suffered its worst return (–3.84%) since August 1998’s –5.05%, which was a response to Russia’s sovereign default. The November 2000 sell-off was seen as excessive relative to the fundamentals, as evidenced by December reports that Warren Buffett and other value investors were snapping up depressed high-yield bonds.

high yield OAS

To summarize, no two market circumstances are exactly identical. Measuring the impact of an event such as a hung election is inevitably complicated by other, concurrent events. Without downplaying these limitations, we submit that the high-yield widening of 119 bps in the period of uncertainty that followed the Nov. 7, 2000 presidential vote represents the best available estimate of the likely impact of a replay this year.

Investors should keep in mind, though, that the Oct. 25–Nov. 4 widening of 60 bps may indicate that the market has discounted half of the impact in advance. (By contrast, the market was probably caught off-guard by 2000’s unusual turn of events, implying that previous spread-widening was strictly a function of high-yield fundamentals.) – Martin Fridson

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Research assistance by Yanzhe Yang and Jiajun Wang.

Marty Fridson, Chief Investment Officer of Lehmann Livian Fridson Advisors LLC, is a contributing analyst to S&P Global Market Intelligence. His weekly leveraged finance commentary appears exclusively on LCD, an offering of S&P Global Market Intelligence. Marty can be reached at [email protected]

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Murray Energy High Yield Debt Advances on Word of Oil Reserve Selloff

Debt backing Murray Energy advanced following the news that the coal company is selling off nearly 6,000 acres of its Utica Shale natural gas and oil reserves for $63.6 million.

murray energyThe 11.25% second-lien notes due 2021 backing Murray Energy initially gained as much as 5/8 of a point on the news, to 75.875, before giving back the gains to trade in and around 75.25, trade data show. The bonds are currently sitting close to 15-month highs after trading down to just 12 cents on the dollar amid litigation woes and plunging coal prices.

Murray’s B-2 term loan due 2020 (L+650, 1% floor) was at a 91 bid today, up about a point and a half from yesterday, sources said.

Murray didn’t name the buyer for the eastern Ohio assets in the announcement, but said it expects to receive $48.6 million when the sale closes, and two other payments of $7.5 million each in 2017 and 2018.

As reported, Foresight Energy, part owned by Murray Energy, completed its out-of-court restructuring of more than $1.4 billion in indebtedness in August after the Delaware Chancery Court in December ruled that a revised “partnership” deal implemented by part-owner Murray Energy demonstrated a “de facto” change in control, putting Foresight on the hook to repay a $600 million bond issue at 101%.

With long-term debt of $1.5 billion and a cash position of $16.2 million as of March 31, Foresight did not have sufficient liquidity to repay the debt in the event of acceleration.

Murray Energy is a coal company with mining operations in Ohio, Illinois, Kentucky, Utah, and West Virginia. — Kelsey Butler/Rachelle Kakouris

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This story first appeared on www.lcdcomps.com, an offering of S&P Global Market Intelligence. LCD’s subscription site offers complete news, analysis and data covering the global leveraged loan and high yield bond markets. You can learn more about LCD here.

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S&P: Growth in Global Credit Demand to Continue. Then: Slow Burn or ‘Crexit’?

corporate debt levels

S&P sees global corporate credit demand growing over the next few years, to $62 trillion by the end of the decade, including some $24 trillion in “new” debt (as opposed to refinancings).

At the same time, borrower credit quality is weakening , thanks largely to “monetary expansion” in various countries.

This combination of factors leads S&P to a pair of scenarios, with the assumption that a credit correction of some kind is inevitable:

  • A slow burn, where weak companies fall over gradually (this is the base case assumption)
  • “Crexit”: A system-wide credit contraction, prompted by a series of economic/political shocks. Brexit, for instance … – Tim Cross

 

The full report, Global Corporate Credit: Despite An Inevitable Credit Correction, Debt Demand Will Swell To $62 Trillion Through 2020, is available to S&P Global Credit Portal Subscribers. It was written by Terry Chan, Diego Ocampo, David Tesher, and Paul Watters. It details:

  • Global corporate credit demand, by country
  • New corporate credit demand
  • Corporate credit growth cycle
  • Debt/GDP vs Credit growth
  • Financial risk trends of global corporate sample
  • Distribution of FFO/debt risk categories, by country/industry

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Europe: Crossover Index widens roughly 100 bps as UK Votes to Leave

So there we have it – the U.K. has done what many in the financial markets thought it wouldn’t, and voted to leave the E.U. Early reactions from those awake as the outcome became clear in the early hours ranged from disbelief, to sadness, to a sense of real uncertainty as to what lies ahead. Some were simply lost for words.

The markets, however, have been very clear in their reaction with the Market iTraxx Crossover Index pointing the way to what is expected to be a volatile and difficult trading session. The index widened out by up to 130 points by 6 a.m. BST following the pound’s cliff-edge nose-dive during the night to its lowest point in over three decades. It has since recovered some of that ground and is currently roughly 30 bps off the morning’s wides.

High-yield is expected to take its lead from equities, and Ineos’ bonds were already off five points by 6 a.m., with sources saying roughly a quarter of market players were already at their desks judging by the green dots on Bloomberg. Sources say that actual trading activity is taking place, which at least suggests the secondary market is functioning.

The loan market tends to be less reactionary – aside from those names with bonds outstanding – but even loan names were one-to-three points lower across the board, sources say.

Uncertainty is likely to be the most overused word of the day, and the 51.8% to 48.2% Vote in favour of Leaving is certainly close, prompting much discussion about what happens next – will the Vote actually lead to a Brexit, will it trigger a chain reaction across Europe, what next for Scotland, will there be a recession, what will happen to the City, and its financial institutions, will David Cameron step down?

It is not for LCD to comment on these much bigger questions, but we will endeavour to publish some constructive commentary on the implications for the leveraged finance market during today’s session. In brief, expect volatility to be the order of the day in secondary, while primary markets will pause to take stock, although for how long remains to be seen. — Sarah Husband

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This story first appeared on www.lcdcomps.com, LCD’s subscription site offering complete news, analysis and data covering the global leveraged loan and high yield bond markets. You can learn more about LCD here.

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Distressed Debt: Key Energy Cut to CC on Proposed Restructuring, Likely Ch.11Fiiling

S&P Global Ratings has cut Key Energy Services to CC, from CCC+, after the oilfield services company today announced that it has entered into confidential agreements with certain holders of its 6.75% senior notes due 2021 and certain lenders of the term loans regarding a proposed financial restructuring.

The outlook is negative, reflecting the high likelihood that Key will seek to restructure its debt through a prepackaged Chapter 11 proceeding once it comes to terms with creditors, S&P said in its report.

Key Energy said in an 8-K filing that the discussions with its creditors remain ongoing, with both sides presenting proposals.

Based on the disclosures filed, the creditors’ proposal contemplates, among other things, an exchange of all outstanding notes for 100% of the equity of the reorganized Key Energy, subject to dilution as a result of a $75 million rights offering, the proceeds of which would be used together with other available funds to repay $63 million in aggregate principal and interest of the term loans at par, with the remaining $250 million principal balance of the term loans to remain in place, subject to certain modifications agreed upon among the creditors. Also, under the creditors’ proposal, vendors and other general unsecured creditors would be paid in full. Further, eligible Key Energy shareholders would receive the ratable right to acquire up to 8% of the equity of the reorganized company pursuant to the rights offering and ineligible shareholders would be entitled to a ratable share of a $100,000 payment.

Key’s counter proposal addresses, among other things, calls for existing shareholders to receive 5% of the reorganized equity.

Total senior debt at the company was roughly $988 million as of March 31, including $675 million of 6.75% senior notes due 2021 and $312 million outstanding under its term loan due 2020 (L+925, 1.00% LIBOR floor.)

Houston–based Key Energy Services operates as an onshore rig-based well servicing contractor in the U.S. and internationally. The company trades on the NYSE under the ticker KEG and has a market capitalization of approximately $47.2 million. —Rachelle Kakouris

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This story first appeared on www.lcdcomps.com, LCD’s subscription site offering complete news, analysis and data covering the global leveraged loan and high yield bond markets. You can learn more about LCD here.

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Fridson: Energy, Commodities High Yield Bonds See Lofty Returns in March

The energy and commodities sectors led the stomach-churning plunge in high yield during the second half of 2015, so it stands to reason that those market segments had the most upside as the first quarter of 2016 progressed. Indeed, as Martin Fridson notes, commodities and energy bonds saw eye-popping (and even unprecedented) gains last month:

In March the commodities industries recorded their highest monthly returns since industry performance on the BofA Merrill Lynch US High Yield Index became available in June 1996. The BofA Merrill Lynch US High Yield Energy Industry returned 16.07%, and the BofA Merrill Lynch US High Yield Metals/Mining Industry returned 8.86%. Those two returns topped the month’s league table for performance among the 20 largest high-yield industries.

This story is part of Marty’s weekly high yield bond analysis which appears on www.lcdcomps.com, LCD’s subscription site offering complete news, analysis and data covering the global leveraged loan and high yield bond markets. You can learn more about LCD here.

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Fridson: Found! The Turning Point for High Yield Bond Overweighting

This article was originally published by LCD News, for subscribers, on Sept. 29, 2015.

Synopsis: A simple rule derived from the definition of distressed debt has consistently generated alpha for tactical asset allocators in past high-yield recoveries from market lows.

The challenge: When to pull the trigger?

The large variance in short-run returns among asset classes during major market turns produces huge payoffs for successful tactical asset allocation. Consider, for example, what a fixed-income manager could have achieved following the 2001 recession by astutely varying the relative weights of investment-grade and high-yield corporates. In the second quarter of 2002, the investment grade BofA Merrill Lynch US Corporate Index trounced the BofA Merrill Lynch US High Yield Index, 4.37% to -6.98%. One year later, the tables turned, with the HY index crushing the IG index, 10.02% to 2.47%, in the second quarter of 2003.

Given these rewards, why doesn’t every money manager grab oodles of alpha by reallocating during major market turns? The problem is that it requires calling the turn. Classically, the relatively undervalued asset may get more undervalued before the market comes to its senses. Jumping in too early can be disastrous for managers who do not have the luxury of being evaluated only on a multiyear basis. For those trying to put up good quarterly numbers, it is not good enough to say, “I am confident that in the fullness of time the market will recognize the wisdom of my positioning, even if I suffer a year or two of underperformance in the interim.”

Here is the good news: A startlingly simple timing signal has consistently paid off over a three-month horizon in recoveries from high-yield cyclical bottoms. Recognize upfront that the methodology does not guarantee capturing the cyclical rebound’s highest three-month return and the historical sample size is small. With those caveats, the trading strategy is a bona fide no-brainer and has reliably generated very substantial alpha.

Breaking through 1,000

The easy-to-remember rule for deciding when to step up high-yield exposure is to pull the trigger the day after the option-adjusted spread (OAS) on the BofAML High Yield Index falls below 1,000 bps.

High-yield cognoscenti will recognize the 1,000 bps level as the threshold for defining distressed bonds, a standard I introduced some 25 years ago. At an OAS of 1,000 bps, the market is essentially saying that the high-yield asset class as a whole is distressed. When the spread moves out of that territory, the market is signaling that financial distress is receding.

To test this trading rule, I measured three-month returns on the BofAML High Yield Index, the BofA Merrill Lynch US Non-Distressed High Yield Index, the BofA Merrill Lynch US Distressed High Yield Index, the BofA Merrill Lynch US Treasury & Agency Index, and the investment-grade BofAML Corporate Index. I started each trial on the first trading day after the spread first fell below 1,000 bps. Future users of this strategy do not have to predict anything or exercise any judgment, but can instead wait to act until the decisive piece of information has arrived.

For the period preceding OAS availability on the BofAML High Yield Index, that is, prior to Dec. 31, 1996, I used the yield-to-maturity (YTM) difference between the BofAML High Yield Index and the BofA Treasury & Agency Index. (Yield-to-worst figures are also unavailable prior to Dec. 31, 1996.) This substitution is justified by a comparison of the YTM spread and OAS during the period in which both are available. From Dec. 31, 1996 to Dec. 31, 2014, the median monthly difference between the two versions of the spread, when OAS was in a range of 900-1,000 bps, was – remarkably enough – one basis point. (The YTM version was higher by that amount.) As a point of interest, the gap increased as OAS declined.

Note, in addition, that the inception date of the BofAML Non-Distressed High Yield Index and the BofAML Distressed High Yield Index is, you guessed it, Dec. 31, 1996, so returns are not available on those indexes for the first two trials depicted in the table. Finally, the high-yield market had just one cyclical low in the early 1990s, but the high-yield spread exited the distressed zone twice. After falling below 1,000 bps on Dec. 24, 1990, the spread later rose above that threshold before definitively dropping below it on Feb. 12, 1991. (The first trial in the table commences after the market’s closure for Christmas on Dec. 25, 1990.)

Results

In all five trials high-yield outperformed governments by at least 5.10 percentage points and in the most extreme case, by 13.28 percentage points. Note that these are non-annualized, three-month returns. On an annualized basis, the high-yield returns during the five episodes documented here ranged from 30.32-78.99%. High-yield similarly outperformed IG corporates every single time, by margins ranging from 2.75-12.13 percentage points.

In the three trials in which returns are broken out by distressed and non-distressed, dynamic asset allocators following the 1,000 bps rule and achieving average results would have beaten governments by 2.51 to 4.90 percentage points without needing to own a single distressed issue. The non-distressed high-yield performance edge over IG corporates was likewise substantial in both 2001 and 2009. Naturally, coming off the bottom, the distressed component of the high-yield market turned in exceptionally high returns, ranging from 63.29-174.40% in annualized terms.

Not engineered to catch the absolute bottom

Based on an admittedly limited historical record, the simple 1,000 bps rule generates a substantial three-month performance bonus for tactical asset allocators. Adopters of the trading rule should be forewarned, however, that I have not solved the problem of precisely calling the bottom. Indeed, the high-yield OAS may narrow by hundreds of basis points, producing sizzling high-yield returns, before it finally cracks the 1,000 bps barrier.

The table below compares the high-yield returns captured by the 1,000 bps rule during the high-yield market’s four cyclical recoveries with the peak quarterly returns observed in those cycles. In 2001 the 1,000 bps rule actually produced a return slightly higher than that of the best quarter of the cyclical rebound. In the others, an asset allocator astute enough to have entered at the start of the peak quarter did materially better than followers of the 1,000 bps rule. For mere mortals, however, adding hundreds of basis points over comparable-period returns on high-quality bonds is an outstanding achievement.

Marty Fridson, Chief Investment Officer of Lehmann Livian Fridson Advisors LLC, is a contributing analyst to S&P Capital IQ. His weekly leveraged finance commentary appears exclusively on S&P Capital IQ LCD. Marty can be reached at [email protected].

 

Research assistance by Yueying Tang and Zizhen Wang.

 

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Walking Wounded Lead High Yield Bond Mart to Sensational Early-October Returns

After a bad September and worse three quarters of the year the U.S. high yield bond market rebounded dramatically last week, posting positive returns rarely seen in the asset class, says LCD bond guru Martin Fridson.

Last week the high-yield market staged a spectacular rebound from its worst month since June 2013 and its worst quarter since the third quarter of 2011. (The BofA Merrill Lynch US High Yield Index returned –2.59% in September and –4.90% in the third quarter of this year.) From Friday Oct. 2—when the index’s option-adjusted spread (OAS) maxed out at 683 bps—through Oct. 9, total return measured 2.70%. Fewer than 1% of all weeks since the BofAML High Yield Index’s Aug. 31, 1986, inception had a higher total return. Indeed, the weekly return of 2.70% was higher than the median for all quarters since the index’s inception. High-yield’s herculean performance coincided with a bracing 3.30% weekly return for the S&P 500 Index of common stocks.

Why the rebound? The laggard high yield industries that had fallen furthest throughout the year apparently now have found favor. Fridson:

Returns were even more sensational among industries that spearheaded the prior downturn. The chart below details one-week returns for the third quarter’s biggest losers. In the case of the BofA Merrill Lynch US High Yield Energy Index, the return was a bit more than twice that of the overall index.

high yield bond returns

This analysis is taken from Marty’s weekly column, available to LCD News subscribers here. – Tim Cross

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High yield bonds: Telecom replaces energy as worst-performing industry in September

High yield players were awfully glad to turn the calendar on a dismal September, which produced the worst monthly performance for the asset class since June 2013, according to bond guru Martin Fridson.

And there’s a new poster child for the return-challenged market – for now, anyway. Telecoms replaced the long-beleaguered energy sector as the worst-performing industry in September.

Fridson, writing for LCD News:

Although Energy and Metals & Mining, August’s two worst performers, remained near the bottom of the peer group [in September], their returns were not as low as in August. Telecommunications plunged from #7 in August, at –0.45%, to #15 out of 15 in September, at –5.34%.

The most dramatic event in that industry was a plunge in Sprint bonds following a Moody’s downgrading from B2 to Caa1. That large issuer’s decline did not distort the overall performance of the telecom sector, however. Bonds of seven other Telecom issuers posted total returns of –5% or less in September, with the Wireline, Wireless, and Satellite subindustries all represented among those severely underperforming companies.

For the record, here’s how industries fared in September.

high yield returns by industry

The relative respite for energy-related issuers could be short-lived however. Fridson goes on to note that S&P recently took an axe to energy ratings, boding ill for that category, obviously. – Tim Cross

Marty’s full analysis is available to LCD News subscribers here. 

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Loan default rates climb in August amid weakness in Energy sector

After a two-month absence, default activity resumed in August, when two energy names – Samson Resources and Alpha Natural Resources – defaulted on $1.6 billion of S&P/LSTA Index loans. As a result, the lagging-12-month default rate climbed to a five-month high of 1.30% by amount, from July’s 33-month low of 1.11%, and to 0.78% by number of issuers, from a 7.5-year low of 0.57%.

Loan index defaults Aug 2015