Analysis: Slow growth a boon for some triple-C junk bonds

By Natsuko Waki

LONDON (BestGrowthStock) – Tepid growth without a return to a recession may be just the climate to tempt investors into triple-C-rated bonds, the riskiest segment of the high-yield corporate debt market.

Triple-C bonds are the type of corporate bonds many investors hesitate to touch because issuers tend to have weak balance sheets, negative cash flows and high default risks.

However, in a slow-growth environment where equity returns are sluggish, getting a double-digit yield that is almost four times higher than emerging market sovereign debt on a bond which pays up at maturity may be one reason they may be tempted.

Moreover, the actual risk of default for junk bonds in general is also falling. Moody’s expects the default rate of speculative grade bonds — rated Ba1 and below — to dip below 2 percent within a year, compared with over 11 percent a year ago.

“Some triple-C names are yielding around 20 percent. At those levels, you could argue that fears of an economic slowdown are already baked into these bonds,” said Theodore Stamos, co-head of credit at Investec Asset Management.

“In a slower-growth environment, you might still be getting paid for the risk… Overall, I’m bullish on the high-yield market.”

Triple-C securities currently offer a spread of around 1,147 basis points over U.S. Treasuries, near this year’s peak, according to Bank of America Merrill Lynch.

Illustrating the yield appeal, this compares with 745 bps, the annual average break-even credit spread required to compensate for defaults over a five-year business cycle, Danske Bank’s analysis shows.

“Despite the fact that credit markets remain turbulent on the back of the sovereign debt crisis, the default cycle has clearly turned, and the global default rate is set to decline further in the months ahead,” Danske said in a note.

“With the yield curve remaining steep and equity volatility continuing to indicate that investor risk aversion remains on the high side … we recommend a moderate overweight in high-yield credit.”

DEEP DIVE NEEDED

Many investors in the illiquid distressed space adopt a long-term buy-and-hold approach and must often conduct in-depth analysis on relative value, cash flows, relevant sectors and underlying assets.

Investors also eye an “exit” strategy, such as a recapitalization, buy-out or initial public offering to create value for the portfolio.

“Triple-C names all have a great deal of idiosyncratic risk. You have to look at them on a name-by-name basis,” Stamos said.

“Buying distressed triple-C paper involves more work. You have to have an analyst doing a deep dive and spending a lot of time to get to know the credit.”

Investec owns senior unsecured paper for market research firm media firm Nielsen, best known for its viewership ratings.

The company plans a $1.75 billion initial public offering after it was taken private in a $10 billion deal in 2006 by a group of private equity firms. Stakeholders include Kohlberg Kravis Roberts, Blackstone (BX.N: ) and Carlyle Group.

WALL OF MATURITIES

Many high-yield bonds have escaped the worst of the recent sell-off as investors nervous about sovereign debt risks bought lower-rated industrial sectors to diversify away from financial issues, many of which are in investment grade.

Companies in the media, entertainment, high technology and oil and gas sectors account for over 59 percent of U.S. distressed debt, according to Standard & Poor’s.

One hurdle faced by investors in triple-C debt might be a wall of debt maturities in 2012-2014, with the required refinancing amount estimated to be around $600-800 billion.

“Many of these companies will likely need to undergo material balance sheet restructurings. This … presents opportunity for investors,” bond manager PIMCO said in a note to clients.

“We expect there to be significant distressed investment opportunities for those investors who can combine outstanding market sourcing capability, a clear grasp of the macro environment, deep industry research insights and broad restructuring experience.”

(Editing by Stephen Nisbet)

Analysis: Slow growth a boon for some triple-C junk bonds