DDJ Capital Management Blog

In our third edition of this blog series on 144A bonds, we explore the difference in rating agency classifications between 144A high yield bonds relative to non-144A high yield bonds.

If you have not yet read the first two installations of this blog series, here are links to get you started:

• Part 1 - 144A Bonds and Why We Buy Them - discussing what these securities are, their increased importance in the high yield market, and why DDJ believes institutional investors seeking exposure to high yield should embrace investing in Rule 144A issuances.
  
  
• Part 2 - The Prevalence of 144A-For-Life Bonds – elaborating on an important trend in the high yield bond market: the prevalence of so-called “144A-for-life” bond issuance (i.e., those issued without registration rights) relative to 144A high yield bonds issued with registration rights.

The exhibit below displays the ratings classifications of the Bloomberg Barclays U.S. High Yield Index – broken out into 144A bonds (which includes both 144A-for-life and 144A with registration rights) and non-144A bonds.

November 1 - November 30, 2020

Summary

• Leveraged credit markets produced impressive gains in November.
• Lower-rated credits in the high yield bond and leveraged loan markets meaningfully outperformed higher-rated peers.
• Prospects of continued political gridlock in the U.S. and positive COVID-19 vaccine news drove performance, with COVID-sensitive sectors outperforming.
• Strong returns occurred while daily coronavirus infections, hospitalizations, and ICU patients all hit record highs during the month.

As many expected, the outcome of the U.S. presidential election and a number of Congressional races remained too close to call on election night, with the prospect at the time that it could take days or even weeks until all votes were counted. However, election night did not result in a “Blue Wave” as many had predicted, with a continued divided government appearing to be the most likely outcome. Despite the uncertainty with who would be the next president in the immediate aftermath of the election, risk markets, including leveraged credit markets, rallied on the prospects that more gridlock in Washington would decrease the likelihood of any significant legislative changes being implemented. Less than a week after the election, media channels began to announce Democrat Joe Biden as President-elect and that the Democrats had retained control of the House of Representatives, albeit by a diminished margin. In the Senate, Republicans will hold 50 seats to 48 for Democrats, with the remaining two outstanding Senate seats in Georgia headed to a runoff election on January 5^th.

October 1 - October 31, 2020

Summary

• October was a volatile month for leveraged credit markets, which produced modest gains.
• Lower-rated credits in the high yield bond market lagged, while lower-rated leveraged loans outperformed.
• We provide a few thoughts on the upcoming U.S. elections.
  
  

In last month’s High Yield Bond & Leveraged Loan Review, we stated that we expected October to be a volatile month for markets, and it did not disappoint. At the beginning of the month, markets were faced with the news of President Trump’s COVID-19 diagnosis and subsequent hospitalization. Since that time, COVID-19 cases have steadily risen in the U.S. and across the globe. In particular, the spread across Europe has resulted in renewed lockdowns and further restrictions, albeit to a degree far less draconian to date than those of the spring. In the U.S., rising number of infections have brought the country’s total number of cases to more than 9 million, with hospitalizations similarly increasing. Nonetheless, continued progress on how best to treat patients with the virus has increased survival rates, in particular among those hospitalized.

September 1 - September 30, 2020

Summary

• In September, leveraged loans produced a gain and outperformed high yield bonds, which experienced a loss for the first time since March.
• CCC-rated bonds and loans generated positive performance and outperformed their higher rated peers.
• We conduct a deeper dive into spread changes in the CCC-rated segment of the high yield market. 

In general, various indicators continue to show improvement in overall economic activity as the U.S. economy resumes its reopening. Unfortunately, such renewal in activity has coincided with a surge in COVID-19 cases. However, and thankfully, the most recent surge or “second wave” in the U.S., and abroad, has yet to result in an alarming increase in hospitalizations or mortality rates. That said, the recent announcement that President Trump has tested positive for COVID-19 will create further uncertainty and likely inject volatility into the markets.

When many investors hear terms like “default” or “bankruptcy”, negativity and losses probably come to mind, and for good reason. Over the past 25 years, on average, when a high yield bond has defaulted, investors lost almost 60 cents on every dollar invested.¹

“Rule 144A is therefore very valuable to issuers, as it reduced the cost of capital by improving the liquidity of the institutional secondary market for privately placed bonds.”
– Andrew Ross, CFA, Director, Portfolio Specialist

Not familiar with 144A bonds? You’re not alone. Given the growth of bonds issued via Rule 144A (“the Rule”) and their increased importance in the high yield market, we thought it would be informative to provide a brief overview of Rule 144A and the bonds issued under this rule.

August 1 - August 31, 2020

Summary

• In August, high yield bond and leveraged loan markets delivered gains of 0.98% and 1.50%, respectively

• The presidential election moved to the forefront, with increased volatility likely to occur in coming months

• The Fed announced a change to inflation policy expected to keep interest rates “lower for longer”

• Issuance in August was much higher than expected, driven by BB-rated issuance

Presidential politics moved to center stage in August as both political parties hosted their respective conventions, albeit somewhat unconventionally due to the ongoing pandemic. In all likelihood, the market will increasingly focus on the upcoming U.S. presidential election, with heightened volatility occurring as a result. In addition, the fragile relationship between the U.S. and China deteriorated further in August, as President Trump, citing national security concerns, issued an executive order in an effort to either try and force the sale of the popular social media app TikTok, which is owned by a Chinese company, to an American company or otherwise require it to close its U.S. operations. Furthermore, the U.S. State Department requested that U.S. colleges and universities divest Chinese holdings in their endowment portfolios. The markets will be closely monitoring for any negative developments between the two countries that could threaten the adherence to the previously agreed-upon Phase 1 trade deal.

July 1 - July 31, 2020

Summary

• In July, while leveraged loans produced a gain, they lagged the high yield bond market, which delivered its best monthly return of 2020.
• The Bureau of Economic Analysis provided confirmation of Q2’s historic GDP decline.
• The Fed announced an extension of its monetary support measures through year-end.
• With BB-rated bonds producing positive returns year-to-date, inside we take a closer look at the spread compression of this Cohort in recent days.

At the end of July, the U.S. Bureau of Economic Analysis released its Q2 GDP estimate, which was pretty dramatic. It showed that the U.S. economy had shrunk by a record setting -32.9% annualized rate, which is more than three times the previous record of -10% set back in 1958.¹ Although a decline of this magnitude was expected, and likely already priced into the market, it provides good context for the scale of the economic disruption caused by the COVID-19 pandemic. In addition, digging into the details of the release reveals that the vast majority of the decline came from a massive reduction in personal consumption.

June 5 - June 18, 2020

Summary

• Despite an increase in volatility driven by renewed concerns regarding a resurgence of the coronavirus, leveraged credit markets produced modest gains.
• Flows and new issuance remain strong for high yield bonds, though not as much for leveraged loans.
• We briefly analyze the industry standard calculation of the recovery rate on defaulted debt, highlighting some of the limitations of such measure.

On June 5^th, investors were greeted with a much better than anticipated May U.S. employment report, with an increase in non-farm payrolls of 2.5 million relative to consensus for a decline of 7.5 million. The report also reflected a decline in the unemployment rate  from 14.7% in April to 13.3% in May, also moving in the opposite direction as forecasts, which called for an increase in the unemployment rate to 19%. Such a rate would have represented the highest level since the 1930s. In addition, retail sales for May increased by a record 17.7% month-over-month, handily beating expectations for an increase of 8%. Such reports added to an already optimistic outlook amongst investors for a strong economic recovery beginning in the third-quarter, driven by a largely successful reopening of the U.S. economy.

May 22 - June 4, 2020

Summary

• Leveraged credit markets produced impressive gains during the period covered and have done so for two consecutive months.
  
  
• We briefly analyze the performance of the CCC-rated bond market to better understand its relative underperformance since the recovery began.

Worldwide, confirmed cases of COVID-19 exceed 6.5 million, with cases in the United States accounting for 28% of the global total. The unprecedented steps taken in the U.S. and other countries during March and April to minimize the spread of the virus have resulted in a decline in infection rates in many areas. However, there remain several countries that continue to show a rapid growth in cases, such as Brazil and Russia. Although not unique to the U.S., the restrictive measures undertaken domestically to reduce the spread of the virus have had a major impact on economic activity. Unemployment has soared and GDP in Q2 2020, which includes the height of the lockdowns, is anticipated to show an annualized rate of decline between 30-50%. Nevertheless, with the lockdowns easing across the nation, many economists believe that the worst of the economic malaise is behind us.