One month ago we reported that the junk bond market had effectively frozen as a result of surging spreads, or as the FT put it "ground to a halt", because for the first time since November 2008, not a single high-yield bond had priced in the market in the past 30 days. Today, the Wall Street Journal picked up on this, reporting that "December was the first month since 2008 without a junk-bond sale." In fact, the market had gone for a whopping 40 days without a sale, the longest stretch in data going back to 1995. The reason for the bond issuance drought was a familiar one: "volatility in financial markets, uncertainty about the economy and the recent drop in oil prices are discouraging riskier companies from issuing debt and investors from buying it."
Of course, it hasn't been a complete freeze for the junk market, which was hit with $101 billion in net investor outflows in 2018. As we noted previously, whereas there has been no bond issuance in the past 6 weeks, loan issuance has been lively, if subdued, totaling $25 billion in November and December according to LCD. But that was still a significant slowdown from previous months.
As the WSJ notes, the drop-off in debt issuance, whether junk or not, is important because it "complicates companies’ efforts to invest in plants, equipment or other business infrastructure, a key component of economic growth" (this is different from IG company borrowing needs, where the funds are usually used to fund M&A and/or stock buybacks). Additionally, firms borrowing in the high-yield bond market are also among the most sensitive to changes in financial conditions. Significant increases in their borrowing costs, particularly at a time when economic growth is slowing down, will sharply boost their chances of bankruptcy.
Once they begin, dry spells in debt markets can persist, as few potential borrowers are interested in being the first to test investors’ appetite for new bonds. Among the businesses currently waiting to issue debt is the automotive-battery business that Johnson Controls International PLC is selling to a group led by Brookfield Business Partners . That deal is expected to be funded with roughly $10 billion of debt. Investors and bankers say it could take smaller bond and loan sales to pave the way for larger deals, and the successful completion of one large transaction could open the door for others.
Jim McDonald, chief investment strategist at Northern Trust, said recent losses in risky assets such as junk bonds and stocks could dent risk appetite among investors after a near-decadelong run of gains: “Tighter financial conditions can lead to slower growth."
To be sure, the market volatility also caused many businesses to delay or cancel planned debt sales, complicating at least one large acquisition, the LBO of aerospace-parts maker Arconic which is currently valued at about $14 billion including debt. The Wall Street Journal reported in July that private-equity groups were considering purchasing the Alcoa spinoff in what would be one of the largest LBOs of recent years, but the sales process has dragged out in part because of the difficulty of securing debt financing in this environment.
All of that is about to change however, and the freeze in the junk bond market is about to end because as Dow Jones notes, Targa Resources Partners, a junk bond-rated midstream energy company with ratings at the upper end of the speculative-grade spectrum, was set to sell $750 million of bonds due 2027, in part to refinance debt coming due soon.
The Targa bond sale, if successful, would end a historic dry issuance spell stretching back some 24 years.
Making the bond sale possible is the modest rebound observed in debt markets over the past week as high-yield bonds rallied since the end of last week rallying alongside stocks in the wake of a surprisingly strong jobs report and dovish comments from Jerome Powell. The average junk-bond spread was 445 bps on Wednesday, down from 537 bps on Jan. 3, its highest level since August 2016.
Of course, the attempt to break the ice in the bond market won't come cheap to Targa or its underwriters, and according to preliminary guidance by lead underwriter Bank of America, the notes would yield in the high 6% range, a sizable premium to the yield on Targa’s existing bonds.
Consider it Targa taking one for the team because should the freeze in the junk bond space be cracked, many more issue will emerge. Indeed, speaking to the Journal, investors described Targa as the type of company they might expect to break the ice for the high-yield market, given its relatively solid ratings and familiarity to fund managers. Even so, the proposed yield concession on the debt reflects a market that might just be on the mend but still faces uncertainty following weeks of price declines and outflows from high-yield mutual funds. To be sure, if any of the investors suffer losses in the days past break of trading, investor appetite will only sour further which is why BofA is offering such generous concessions.
Ultimately, however, the deal will likely get done, although probably wide of initial price talk.
As for the broader market, its fate may rest in the broader economy, which however is still growing, boding well for the high-yield market, said Jim Sarni, a managing principal and bond manager at Payden & Rygel. Predictably, he is betting that the market will recover. Jim, however, won't put an initial allocation where his mouth is and rather than buying the bonds, he is opting to purchases swaps that increase in value as the gap between yields on junk bonds and Treasurys narrows.