Credit Market Moves Toward Breaking Point as Investors Flee, Sales Flop

(Bloomberg) – Credit markets are beginning to buckle under the pressure of rising yields and fund outflows, leading strategists to fear a rupture if the economy slows.

Banks were forced to complete a $4 billion leveraged buyout funding this week as investors pushed back on a risky bankruptcy exit deal and buyers of repackaged loans went on strike. But the pain wasn’t limited to junk — investment-grade debt funds experienced one of their biggest cash withdrawals ever and spreads widened to their widest since 2020 after their worst third-quarter returns since 2008.

“The market is out of whack and financial stability is at risk,” said Tracy Chen, portfolio manager at Brandywine Global Investment. “Investors will test the central bank’s resolve,” she said in a phone interview.

In a sign of how bad things are starting to get, Bank of America Corp. tracked measure of credit stress slipped into “critical borderline” this week. “Credit market dysfunction begins beyond this point,” strategists Oleg Melentyev and Eric Yu wrote in a note titled “This Is How It Breaks” on Friday.

More pressure is expected as the Federal Reserve continues to tighten financial markets and raise funding costs at a time when earnings are being squeezed by a slowing economy.

The riskiest CCC-rated bonds result in losses for high-yield bonds. Average CCC-rated debt is down nearly 17% this year, worse than the 15% drop for junk as a whole.

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“You’re really starting to see CCC prices in recession worries,” said Manuel Hayes, senior portfolio manager at Insight Investment. Hayes buys bonds that are better positioned to weather a downturn and calls BBB-rated bonds, the lowest level of investment grade, the “sweet spot.”

A general move away from debt, which is most exposed to an economic downturn, has widened the spread between BB and B-rated debt to the highest since 2016. At the same time, Thursday’s average high-grade spread hit 164 basis points, its widest in more than two years.

And the pain is spreading to all areas of credit, including structured products. Prices for secured debt obligations fall as Wall Street banks pull back from buying the securities under pressure from regulators. That will likely affect issuance by CLOs, the largest buyers of leveraged loans. The average price of the adjustable-rate loans fell to about 92 cents on the dollar, and investors don’t see calm in the markets anytime soon.

Meanwhile, a key spread on mortgage-backed securities hit a two-year high after the Fed pulled out of the market.

“A recession is a foregone conclusion if we’re not already tipping into one,” said Scott Kimball, managing director at Loop Capital Asset Management. “The question is duration and severity, and none of that improved over the quarter.”

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Corporate bond sales in Europe slumped to the lowest level since at least a comparable period in 2014, while a normally booming month of September was overwhelmed with the worst sales for the same year, according to data compiled by Bloomberg. As funding costs soar, the picture for businesses in the region is bleak.

At least 10 bond deals were postponed or canceled globally in September, compared with just one in August, according to data compiled by Bloomberg. That’s the highest level since June, after a rare period of stability over the summer.

Elsewhere in the credit markets:

America

US junk bonds are heading for their worst year-to-date losses as the Federal Reserve maintains a hawkish stance to tame inflation.

  • The investment-grade primary bond market saw no new issuers on Friday, capping a miserable week that saw only $1.7 billion sold
  • The cruise sector is recovering at a slower-than-expected pace as cruise lines Carnival and Royal Caribbean saw bond prices fall on Friday
  • Mortgage-backed securities represent one of the most attractive entry points of the past 10 years given a combination of yield and low prepayment risk, one analyst wrote
  • For deal updates click here for the New Issue Monitor
  • Click here for more information on the Credit Daybook Americas
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EMEA

The region’s primary bond market missed expectations for the issuance at just over 15 billion euros ($14.7 billion), with Friday being the 39th day of no selling this year.

  • Banks funding the House of HR acquisition are likely to keep about a quarter of the deal on their balance sheets, adding to the billions in debt sitting on lenders’ books
  • In the UK, gilts have seen some respite after a recent sell-off on optimism surrounding the government’s meeting with the Office of Budget Responsibility
  • Sustained sales set records in the German bonded loan market, reaching more than EUR 8 billion in the first three quarters of the year, beating the full-year totals of previous years

Asia

The tiny leveraged loan market is dwarfing the US and Europe, with non-Japan-based banks in the region enjoying one of their best years, posting a 40% year-on-year increase in revenue through September, according to data from Bloomberg.

  • Chinese high-yield dollar bonds are on track for their biggest weekly loss since March, capping a seventh straight quarterly decline as debt worries over developer CIFI caused its ratings to plummet
  • India’s primary market was weak on Friday, with borrowers and investors awaiting a fresh rate decision from the country’s central bank

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