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Huge Demand for Junk Bond

In the year to date, corporate high-yield bond issuance globally hit the highest level since records began in 1995, according to data provider Dealogic. April was the highest month on record for corporate junk bond sales in the US, Asia and globally.

With more than $170bn priced this year, sales of junk bonds look likely to eclipse the annual record of $185.4bn set in 2006.

Most companies tapping the market are refinancing money borrowed in the buy-out boom of the past decade. Private equity sponsors have been trying to chip away at what has become known as the maturity cliff, or wall of debt that matures starting in 2012.

The result has been a boom in bond issuance, including junk bonds, the borrowings from companies below investment grade. The trend has been global but has been more noticeable in Europe, where companies have historically preferred private, bank debt finance to bonds.

The strong demand for bond issuance from investors even prompted rating agencies to downgrade default rate forecasts, as more companies were able to refinance than had been expected under the tightening of credit conditions following the crunch.

The cost of bond market funding for junk-rated companies had fallen this year from 8.5 per cent for single B-rated issuers at the start of the year to 7.98 per cent. In recent weeks, yields have reversed, rising again to above 9 per cent. According to Dealogic, while May saw low levels of junk bond issuance, it was not the lowest on record for corporate high-yield bond sales.

Indeed, in spite of a recent sell-off, by late April and early May the prices of junk bonds had rallied so strongly that a key market benchmark suggested they were collectively trading at near 100 per cent of face value, a level not seen since before the credit crisis took hold in 2007.

The move highlights the recovery in investor confidence in junk bonds from a nadir struck on December 12 2008, when the index hit a record low of 54.78. And inflows into high-yield bond funds in the US remain positive in the year to date – totalling $1.23bn, according to Lipper FMI.

In spite of the volatility of recent weeks, bankers believe the junk bond market will remain largely open this year. “The primary calendar is supported by the large amount of required refinancing – nearly $1,000bn in the global leveraged finance market – over the next several years,” says Mathew Cestar, co-head of credit capital markets for Europe at Credit Suisse.

“Investors who are comfortable with risk are allocating money to high-yield bonds that probably would be flowing into stocks if the economic outlook were brighter,” said Martin Fridson, global credit strategist at BNP Paribas Asset Management. Junk bonds are benefiting from the belief they will perform well even if corporate earnings are flat, he said.

“In contrast, stocks cannot go up under those conditions unless price-earnings multiples rise, which seems unlikely,” he added.

Reference:

  1. Financial Times, 20100813, “Sales of Junk Bonds set to reach new high”
  2. Financial Times, 20100622, “End of Drought for High-Yield Bond Funds”