By Sam Goldfarb
Signs of stress are mounting in the corporate-bond market, where
rising interest rates and lackluster demand for new debt have
investors questioning whether a long run of favorable borrowing
conditions for U.S. companies is ending or merely hitting a rough
patch.
The amount of extra yield, or spread, that investors demand to
hold investment-grade U.S. corporate bonds instead of benchmark
U.S. Treasurys in recent days reached its highest level in nearly
two years, while spreads on junk-rated bonds hit a 19-month
high.
The widening gap comes despite a relative dearth of new bond
sales from U.S. companies, a sign that investors' demand has slowed
faster than supply. When businesses have sold debt recently, they
have often struggled to attract much interest, giving investors
more say over interest rates and other key terms.
One source of stress has come from a sharp drop in oil prices,
which exert an especially strong influence on junk bonds because of
the large amount of debt issued by speculative-grade energy
companies. There have also been company-specific problems that have
happened to befall particularly large debt issuers, such as General
Electric Co. and PG&E Corp.
Investors and economists closely watch the corporate-debt market
because changes in borrowing costs can alter investment decisions
and mean the difference between viability and bankruptcy for
businesses at the bottom end of the ratings spectrum.
The recent turbulence in the corporate-bond market has largely
followed swings in stocks, in contrast to some past episodes. To
some investors and analysts, that suggests the latest wave of
selling could reflect a temporary shift in investor sentiment,
rather than fundamental problems with the economy.
Still, there is little doubt that bonds, like stocks, face
challenges. Those start with steadily tightening monetary policy
from the Federal Reserve, which has expressed public concern with
lofty asset prices.
"Fundamentally, the economy is still in good shape and corporate
profits are in good shape, but we just have so many one-off
situations... that everybody is looking for the next problem," said
Kenneth Harris, senior portfolio manager at Segall Bryant &
Hamill. Mr. Harris has been reducing risk in his bond portfolios
throughout the year by buying shorter-term bonds and those with
higher credit ratings.
As of Thursday, the average investment-grade corporate bond
spread was 1.28 percentage points, up from 0.85 percentage point in
February but below the 2.15 level it reached in Feb. 2016,
according to Bloomberg Barclays data. The average speculative-grade
spread was 4.04 percentage points, compared with 3.03 percentage
points in October and 8.39 percentage points in Feb. 2016.
For much of the past decade, analysts have expressed alarm as a
prolonged period of low interest rates has encouraged U.S.
companies to add large amounts of debt to their balance sheets.
Even the lowest-rated borrowers have often been able to issue bonds
and loans that featured minimal protections for investors, making
the debt riskier even as more of it sloshes around the financial
system.
Before traders began selling riskier assets near the start of
October, companies had already started to borrow a little less
while their earnings rose, leading to some modest improvement in
overall corporate leverage ratios. There are recent hints, however,
that the mostly-voluntary slowdown in borrowing could be
exacerbated now by a turn in the market, which some worry could
spell trouble for the economy.
In the past week, for example, hospital operator LifePoint
Health Inc. was forced to make a rash of investor-friendly changes
to a nearly $5 billion bond-and-loan package backing its merger
with private-equity firm Apollo Global Management-owned RCCH
HealthCare Partners.
Several investors expressed concern about the company's reliance
on rural hospitals, which have struggled recently as a result of
declining foot-traffic and efforts by insurers to reduce
health-care costs. Still, the tone of the market aggravated those
concerns. Bonds backing several recent leveraged-buyouts have
fallen below par in recent weeks, and that inevitably led to second
thoughts about buying the latest such offering, investors said.
After shifting $150 million from the bond portion of the deal to
the loan portion, LifePoint ultimately priced $1.425 billion of
bonds at par with a 9.75% coupon, up from initial guidance in the
9%-9.25% range. Even so, the bonds immediately fell in the
secondary market, trading Friday afternoon at around 98 cents on
the dollar for a yield of just over 10%, according to
MarketAxess.
The LifePoint deal was notable because it was the largest sale
of junk-rated debt since riskier assets started to come under
pressure more than a month ago. It came after a few companies,
including oil and gas company GEP Haynesville and brokerage firm
INTL FCStone Inc., were forced to cancel smaller bond sales in
recent weeks.
Attracting demand for sales of debt from highly rated companies
hasn't been as challenging. But it also hasn't been as easy as it
once was. On Wednesday, DowDuPont Inc. was able to sell $12.7
billion of bonds to fund the spinoff of its agriculture and
materials units. Still, the chemical company only did so at
higher-than-expected yield-premiums -- in some cases nearly 0.3
percentage point above what its existing bonds were yielding as
they were headed into the sale.
Corporate bond spreads are still far off the highs they reached
in early 2016, when U.S. crude oil was trading at roughly half
current prices and investors were concerned about the potential for
an imminent recession, let alone during the financial crisis. And
despite the spread widening, investors said, the debt markets
remain far from closed off. In some cases, riskier borrowers have
only needed to move from bonds to loans to raise funds, given
continued demand for debt with floating interest rates.
Still, the DowDuPont sale was one sign that even
investment-grade companies have recently been having a challenging
time, said Ron Quigley, managing director and head of fixed-income
syndicate at broker-dealer Mischler Financial Group Inc. Another is
the 27 investment-grade companies and countries that are known to
be waiting to issue bonds, which is an immense amount to have in
the pipeline, he added.
DowDuPont bonds have held their ground in the secondary market.
A 3.766% note due 2020 was trading at a spread to Treasurys of
around 0.8 percentage point Friday, down from 0.9 percentage point
at issuance, according to MarketAxess.
Write to Sam Goldfarb at sam.goldfarb@wsj.com
(END) Dow Jones Newswires
November 18, 2018 14:23 ET (19:23 GMT)
Copyright (c) 2018 Dow Jones & Company, Inc.