High-yield debt selloff overdone
The selloff in U.S. high-yield debt over the past six months may be over now that junk bond spreads are back near historical averages, but investors should still be cautious about energy-related issues that remain susceptible to lower oil prices.
“If oil stays at a sustained lower level, you will start to see defaults in 2016,” said James Keenan, head of credit at BlackRock Inc., on a conference call Thursday.
Mr. Keenan doesn’t anticipate a wave of defaults this year and believes the recent correction in the high-yield market has created several buying opportunities for investors.
The U.S. high-yield market boasted a 6.5% yield at the end of January, an increase of 123 basis points over a six-month period.
“We think high yield, although in the later stages of a cycle, is still attractive in a balanced portfolio,” he said. “The majority of credit is still in relatively good shape.”
But Mr. Keenan remains very selective about his energy-specific exposure, choosing to invest in only the highest-quality producers, while avoiding the weaker ones whose higher production costs make them more vulnerable to an extended period of low crude prices.
Falling oil prices, without question, have been the major culprit behind the recent selloff in high-yield credit and subsequent rise in their yields since the summer of 2014.
The yield on energy issues, which represent about 15% of the total high-yield market, jumped 434 basis points over the past six months and were yielding 9.8% last month.
The blowout in spreads was led by the oil services sector, which has a credit yield of 13.1%, up 728 basis points, and independent producers, whose credit yield has ballooned 563 basis points to 11.2% in the past six months.
High-yield issues of refiners and pipeline companies have been less impacted by the threat of lower oil prices. In both instances, yields have climbed less than 200 basis points and are near 7.1% and 6.2%, respectively.
Pierre Lapointe, head of global strategy and research at Pavilion Global Markets in Montreal, said the fear of energy names defaulting has pushed spreads in the overall high-yield market back near their historical averages.
As a result, there is upside potential as he expects highyield bonds to resume the rally that has made them one of the best investments postfinancial crisis.
“We expect an increased appetite for corporate bonds to give the space a second wind in months to come,” he said. “The search for yield will keep demand high for higher-yielding corporate bonds.”
Mr. Lapointe added that there is little risk of default for most corporate bonds, noting corporate balance sheets are healthier than they were before the credit crunch.
“The debt-to-total-assets ratio has fallen by more than 10% since the beginning of the recession,” he said. “In other words, companies are less levered than any time in the past decade and should have no problem making their debt payments.”