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Junk Bond - a Haven in Global Bond Rout?

Junk bond returns are beating investment grade by the most since 2009, according to Bank of America Merrill Lynch indexes. Investors in speculative-grade notes globally earned 4.3 percent this year, while the higher-rated bonds forfeited 0.03 percent, the first loss for the period since 2008.

But watch out!  Oil industry has $2.5tn of debt outstanding.  A good chunk of which is considered Junk by the credit rating agencies.  About half the debt is American, and about half the $2.5tn is owed to banks in the form of loans.  Oil price has fallen by more than a third in the past 12 months...as such some are now having to talk to lenders about their rolling credit facilities, which are part of the $1.2tn of outstanding oil industry loans.  Such "bank revolvers" tend to be agreed every 6 months, in April and October.

Credit rating agency Fitch has said defaults start to appear about nine to 12 months after price declines begin.  Moody's last month predicted default rates for exploration and production companies (responsible for a third of the debt total) will rise from 3% in March to 7% next year.  UBS thinks defaults could be twice that rate, in which case the spread between energy debt and the high yield index might be expected to double, from about 150bp to about 300bp.

The price of non-oil related US debt rated triple C, for instance, implies a similar environment to the 2004 to 2007 period, when corporate failures were rare. Yet it is worth noting that the stock of energy related debt is a big one, accounting for about a fifth of the index.

High Yield Bond could be a "safe haven" for now but that status might change in times to come.

Reference

  1. Bloomberg, Katie Linsell, 2015-06-05, "Junk Bonds Proving Haven in Global Bond Rout That's Erased Gains"
  2. Financial Times, Dan McCrum, 2015-06-02, "Warnings Over Oil Debt are Getting Louder"