Companies are rushing to issue — and investors are eager to buy — the riskiest kinds of debt before the Federal Reserve begins tightening monetary policy.
“Issuance this month in the high-yield market has been higher than it normally is,” said Jonathan Duensing, director of investment-grade credit and senior portfolio manager at Amundi Pioneer. “Corporate management teams are trying to get ahead of what they may perceive as a period of higher debt costs in September and October,” he said.
U.S. high-yield issuance of $17.65 billion in the first 18 days of August is up $7.34 billion from July and $865 million more than all of August 2016, according to Informa Global Markets.
Among this month’s high-yield issuance, Tesla on Aug. 11 raised $300 million more than expected with a $1.8 billion junk bond offering at a 5.3 percent yield.
Although the yield was slightly above the original guidance of 5.25 percent, it was still well below the 6.6 to 7 percent range that S&P Global Ratings director Nishit Madlani said a similarly rated bond should have had. Higher yields reflect higher perception of risk.
S&P has a negative B rating on Tesla and a negative outlook.
“High-yield issuers have enjoyed the benefit of not only an economy that is improving, but from some of the lowest yields in history to issue debt, and have been taking advantage of the demand for a number of years,” said Kevin Giddis, head of fixed income capital markets and executive vice president at Raymond James.
The benchmark U.S. 10-year Treasury yield hit a historic, multidecade low last summer and, after a postelection jump, has traded in a range of about 2.1 to 2.6 percent.
The environment of low yields and high investor appetite for risk could change soon.
The Federal Reserve is set to announce in September that it will soon begin reducing its $4.5 trillion balance sheet and the European Central Bank is also expected to cut back its bond purchases in the next several months. Both moves should lead to increased supply of high-quality government bonds and higher interest rates, making it more expensive for companies to borrow money and give investors less incentive to buy high-yield bonds.
High yield and other risky investments appear to already be falling out of favor with investors amid the rising North Korea nuclear threat and political chaos.
Last week, investors withdrew $2.3 billion from high-yield bond funds, the most in nearly six months as high-yield spreads jumped from 364 basis points to 400 basis points, Bank of America Merrill Lynch said in an Aug. 17 report.
In another sign of potential investor anxiety, Tesla’s junk bond price also fell in the last few days, before recovering. The bond was the most actively traded high-yield bond Monday and remained among the top five Tuesday, according to FINRA’s Trade Reporting and Compliance Engine (TRACE).
Tesla bond price
“The recent concern is that if the economy turns, so will high-yield debt yields and liquidity,” Giddis said. “There is a ‘tipping’ point for high-yield debt, and it may not be now, but investors need to be very selective in this environment, because a lot of these companies are ‘high yield’ for a reason, and should not be trading at yields this low. The risk is not knowing or being able to see the difference.”