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credit high yield investment grade Markets

In Credit, Searching For The Last Straw

Yes, it's going to crack, but where first?

“Credit investors turned notably more bearish on fundamentals, a shift that was especially pronounced for HY investors”, BofAML writes, in the latest edition of their Credit Investor Survey.

Considering the survey respondents “expect declining supply”, you’re going to have to look elsewhere for explanations with regard to the dour outlook and BofAML suggests you can blame “the recent decline in oil prices, evidence of input price pressures or maybe the correction in equities.”

In other words: You can “maybe” blame a lot of things, if you really want to.

But whatever you blame, do note that the net share of respondents to BofAML’s survey who expect quality trends to deteriorate within the next six months jumped pretty substantially both for IG and junk, with the percentage change in the latter leaping from just 15% in September to 60% in this month’s survey.

CreditQuality

(BofAML)

There are all manner of factors at play here and despite the best efforts of financial media outlets, capturing them all in one article is obviously impossible.

Clearly, the great “BBB debate” is front and center and as Bloomberg reminds you on Wednesday, the plunge in oil prices isn’t going to do anything to allay concerns considering “energy securities make up some 15% of the BBB rated universe.” This isn’t great:

BBB

GE’s ongoing trials and tribulations are exacerbating fears. CDS spreads on the beleaguered conglomerate’s debt blew out this week to >200bps and obviously, the market fears the worst, Tuesday’s bounce in the equity notwithstanding. You likely already know the story on this, but here’s some extra color from BofAML for those interested in the particulars:

Over the past month, as GE was gradually downgraded to BBB1, its outstanding bonds have now repriced not only to BBB levels, but to BB-rated levels in HY (Figure 1). At the turn of the month, when the company’s index ratings are reduced to BBB1 GE will become the 6th largest BBB rated issuer with just shy of $50bn of outstanding index eligible debt (Figure 2). That represents 0.8% of the IG market, 1.5% of BBBs and 3.9% of HY. When General Motors and Ford were downgraded to HY in 2005 they measured 6.5% and 6.3% of the HY market, respectively. Our view is that GE is small enough, and the story sufficiently idiosyncratic, to leave other large BBB capital structures relatively little affected as this story plays out.

GE

For what it’s worth, Goldman thinks folks aren’t looking in the right place when it comes to downgrade risk. In a note out late last week, the bank reiterated their contention from September that “the risk of a downgrade wave into HY is low.”

Instead of fallen angel risk, Goldman thinks the problem is higher up the ladder in IG.

“$83 billion worth of bonds (issued by GE, AstraZeneca, and Eni SA), have migrated into the BBB bucket from the A bucket, the highest amount since the fourth quarter of 2015 [and] going forward, the risk remains skewed towards further negative actions”, the bank says, adding that “the amount outstanding of bonds on Downgrade Watch by at least one of the three major ratings agencies and currently rated A or A- has actually grown from $111bn at the end of 3Q to $140bn today.”

IGRiskGS

(Goldman)

Whatever the case, the bottom line is that leverage is high, late-cycle fears are surfacing, margin pressure is mounting and there’s a lot of competition from Steve Mnuchin, who is being forced to flood the market with Treasury supply in order to finance Trump’s stimulus package.

And now you can add collapsing oil prices to the mix. Crude’s rapid descent into a bear market has played havoc with HY energy, where yields have surged of late.

HYEnergySpread

So if the question is whether credit is about to “crack”, as it were, the answer is: “Probably”. The real question, though, is: “Where?” Or better: “Where first?”

There are so many different pressure points in the space that it’s well nigh impossible to identify the straw that will ultimately break the camel’s back ahead of time.

All year long, analysts have attempted to decide where IG and HY fall in the hierarchy of risk, and the verdict from the market would appear to be that IG is actually more risky than junk in certain contexts. That said, HY should by all rights be in the firing line as the hunt for yield reverses and risk appetite crumbles.

For what it’s worth, these are the biggest concerns of credit investors polled by BofAML in the survey mentioned here at the outset:

BiggestConcerns

(BofAML)

So you know, pick your poison.


 

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1 comment on “In Credit, Searching For The Last Straw

  1. All the leaves are brown… and the sky is gray…

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