Oct 10 - After trailing off in the spring and early summer, speculative-grade corporate bond issuance in the U.S. has rebounded handsomely in September to the highest amount on record, to $34.9 billion, according to a report published today by Standard & Poor's Ratings Service, titled, "Lowest Rated U.S. Speculative-Grade Bond Issuance Enjoys The Most Favorable Lending Environment In History, But Buyers Need To Stay Mindful Of Risks." Prior to September, the proportion of speculative-grade issuance among the higher ratings ('BB+' to 'B') dominated the speculative-grade market. However, the proportion of new speculative-grade issuance in September in the lowest ratings ('B-' and below) hit a 12-month high of 37.7%.
"Fueling this increased issuance is the continuing falling yields paid out by corporate borrowers over the course of 2012," said Diane Vazza, head of Standard & Poor's Global Fixed Income Research. "Far from being the result of increased creditworthiness by corporate borrowers, this falloff in yield is more a result of investors' search for return among available investment avenues," Ms. Vazza added. This hunt for yield is also happening in Europe, as a result of ultra-low yields on government debt in most of the developed economies, forcing investors to look beyond the safest government debt.
However, while it may be tempting to pile money into the best alternative with regards to payout, the relative risks associated with speculative-grade issuers - and in particular with the lower rated issuers - remains high. Default rates for issuers in the 'BB' rating category are indeed relatively low historically, but the increases in default rates in the 'B' and 'CCC/C' categories are profound by comparison. Add to this, that the trailing 12-month default rate for the 'CCC/C' rating category has been on the rise over the course of 2012, finishing Aug. 31 at 27.2%, indicative of increased stress on this segment of the high-yield market.
Nonetheless, increased risk does appear to at least provide increased rewards for the savvy bond investor, with proper timing being crucial to investment decisions. Over the last seven quarters, returns on 'CCC' and lower rated bonds hit a high of 7.9% in the first quarter of 2012, however, they dropped 10.9% during the two quarters prior to that. Returns for the 'BB' and 'B' categories have been more muted over the same period, but they have also experienced fewer and less severe periods of negative returns. Clearly the potential payoffs to investing in the riskiest speculative-grade bonds can be substantial, however, the potential losses through the combined effects of quickly declining bond prices and elevated default rates within the lowest rated bond categories is just as pronounced. The rationale for moving into this riskiest class of investments in a period marked by such low yields is understandable, but at this point in the high-yield credit cycle investing in the broad market for the lowest-rated debt has become a very risky strategy. Informed credit selection is of the utmost importance heading into the fourth quarter of 2012.
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(New York Ratings Team)