Junk bonds are back

Junk-rated bonds and loans are flying off the shelves again, easing recent worries that a credit-market freeze could harm the economy.

Since Jan. 10, companies with below-investment-grade ratings, including TransDigm Group Inc. and Dun & Bradstreet Corp., have sold around $50 billion of bonds and loans, breaking a dry spell that saw just $29 billion of speculative-grade debt sold in November and December, according to LCD, a unit of S&P Global Market Intelligence.

After hunkering down during the difficult final months of 2018, investors in January found themselves with ample amounts of cash to buy new bonds. In many cases, they have been lured by enticing offers from companies considered relatively creditworthy in the pantheon of junk debt.

Like other risky assets such stocks, junk-bond prices largely have moved in response to the shifting messages of Federal Reserve officials, potentially leaving the market vulnerable if there is another turn by the central bank.

Bond prices fell sharply in early October when Fed Chairman Jerome Powell suggested the Fed had a way to go before it was done raising interest rates. They then rebounded when Mr. Powell reversed course in early January and sent strong signals that the central bank was potentially finished with rate increases for the foreseeable future.

Mr. Powell’s remarks on Jan. 4 “laid to rest the concern that the Fed could make a policy error,” giving investors the green light to start taking risks again, said David Norris, head of U.S. credit at TwentyFour Asset Management.

The amount of junk-rated debt issuance at any time matters for the U.S. economy. While robust sales can saddle companies with unsustainable debt loads and pave the way for subsequent pullbacks, they generally contribute to economic growth by enabling companies to refinance debt and invest in people and equipment. A sharp slowdown in debt sales, as occurred in late November and December, can quickly translate to slower economic growth.

For Fed officials, the fickle nature of debt investors presents challenges. If rates stay low for too long, financial bubbles can form. If the Fed adopts a tougher stance, the risk of a recession is heightened.

While the appetite for junk-rated debt has rebounded in January, there are signs it hasn’t yet returned to the exuberance exhibited before October. Then, concerns were growing about escalating corporate leverage levels and deteriorating investor protections in new debt sales.

As companies sold a hefty amount of debt in recent weeks, they have been forced in several cases to lean on one particular kind of debt — secured bonds — which is garnering more investor interest than secured loans and unsecured bonds.

When TransDigm sought financing last week for its $4 billion purchase of rival aerospace-parts maker Esterline Technologies Corp., it initially sold $3.8 billion of first-lien secured bonds, a record sale for this type of debt, according to LCD. Meanwhile, it dropped a planned $1 billion sale of unsecured notes. Two days later, the company returned to the market to sell another $200 million of secured notes while also issuing $550 million of unsecured bonds.

Similarly, data and analytics company Dun & Bradstreet on Friday sold nearly $4 billion of bonds and loans to fund its leveraged buyout by a group of private-equity companies. But that was only after shifting $100 million each from loan and unsecured bond tranches to secured bonds. It also made several investor-friendly changes to its package of protections, or covenants, placing stricter limits on its ability to issue more debt or pay its owners dividends.

Secured bonds are in a sweet spot because the appeal of loans, which carry floating-rate coupons that fluctuate with short-term rates set by the Fed, has diminished as it appears the Fed is now on hold. Unsecured bonds, whose holders typically are the first among debt investors to take losses in a bankruptcy, have also lost some of their luster amid continued concerns that the U.S. economy is due for a downturn, investors say.

Mr. Powell, at a press conference Wednesday, said officials were paying close attention to financial conditions, including interest rates and yield premiums, “because they have important macroeconomic implications.” Despite easing in recent weeks, he said financial conditions remain “significantly tighter” than they were previously.

At the moment, “the market is very open to good deals,” said Marc Bushallow, managing director of fixed income at Manning & Napier.

Still, Mr. Bushallow said his team didn’t spend much time looking at Dun & Bradstreet’s bond sale because “at this point in the cycle, we’re not buying a highly levered LBO.”

https://www.marketscreener.com/news/Junk-Debt-Is-Back–27952155/