DDJ Capital Management Blog

“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.

May 8 - May 21, 2020

Summary

• Economic data still dire, though signs of gradual improvement from March/April lows
• Leveraged credit markets generated strong returns as progress on reopening the economy overshadowed negative news regarding the current economic situation
• Oil prices rallied in face of declining supply and modest improvements in demand
• Flows and new issuance strong for high yield bonds, less encouraging for bank loans
• We briefly discuss how a surge in fallen angels can alter the composition and risks of high yield market

A clearer picture of the dire unemployment situation in the U.S. emerged on May 8^th when the Department of Labor reported that U.S. payrolls decreased by 20.5 million workers in April, causing the unemployment rate to surge to 14.7% from 4.4% as reported as of the end of March. Both the number of monthly job losses together with the unemployment rate reflected levels not seen since the Great Depression; however, both metrics came in slightly below the forecasts provided by most economists. Unsurprisingly, the Leisure and Hospitality sectors accounted for over one-third of the total number of job losses, as the COVID-19 pandemic has significantly disrupted travel on a worldwide basis. Additionally, initial unemployment claims reported on May 14^th and 21^st came in with 3 million and 2.4 million first time filers, respectively, bringing the nine-week cumulative total to almost 39 million initial filers. While initial claims remain elevated, the silver lining is that such claims have at least declined for seven straight weeks.

April 24 - May 7, 2020

Summary

• The economic impact of the COVID-19 pandemic has pushed the U.S. into a recession.
• Leveraged credit markets managed to produce gains during a volatile couple of weeks.
• We briefly discuss distressed and coercive exchange proposals, as we have recently seen an uptick in this type of activity.

Confirmed cases of COVID-19 have surpassed one million in the U.S. and are approaching four million globally. However, the severity of the pandemic has varied region to region. As a result, certain governments have taken steps to loosen some of the stay-at-home orders, as well as restrictions placed on non-essential businesses, in the hopes of allowing for a modest reopening of the economy. In the U.S., states like Georgia and Florida come to mind as examples where certain businesses have been allowed to reopen albeit at a reduced capacity. Conversely, the hardest hit areas of the country, such as New York, and the Northeast in general, continue to compel citizens to stay at home and mandate that non-essential businesses remain shuttered.

April 17 - April 23, 2020

Summary

• Discussions regarding reopening the economy increased; individual states divided on timeframe.
• Oil prices experienced historic volatility and double-digit declines given oversupply concerns.
• Economic data signals an extraordinary decline in 2Q 2020, brought on by the COVID-19 pandemic.
• Additional government stimulus approved with additional measures likely in near future.
• Volatility continued as the leveraged credit markets generated negative returns.
• YTD performance bifurcation between smaller and larger issue size in the high yield market remains significant.

Investors ended the week on Friday April 17^th on a positive note as risk markets broadly appreciated on encouraging reports regarding drug trials for Gilead Sciences’ drug Remdesivir and its potential effectiveness in treating patients with COVID-19. In addition, the previous evening, the White House Coronavirus Task Force introduced a three-phased approach as guidance for states to gradually begin reopening their economies, providing investors with optimism that that there was a “light at the end of the tunnel.” However, the diversity amongst the state governors with respect to plans to end “stay at home” orders and other virus mitigation efforts was on full display this week as some states extended the duration of such orders while others announced plans to begin rolling back restrictions and reopen their respective state economies in the coming weeks. The differences in perspective are largely driven by the degree to which a particular state has been impacted by the virus with the leaders of less affected states desiring to ease the economic hardship caused by the virus and the associated mitigation efforts sooner rather than later.

1st Half 2019 Review

After experiencing the worst quarterly performance in over three years in the fourth quarter of 2018, the high yield market bounced back in 2019, particularly in the first quarter, generating the strongest first half performance since 2009. A major driver of this rebound in performance occurred at the beginning of the year when the U.S. Federal Reserve (“the Fed”) signaled a more accommodative monetary policy stance going forward. 

1st Half 2018 Review

During the first half of 2018, high yield bonds produced a modest gain of 0.08% (as measured by the ICE BofA Merrill Lynch U.S. High Yield Bond Index (“HYBI”)), representing the worst first half performance by the asset class since the financial crisis of 2008.