Tourist money from investment grade is lowering standards in the high yield market, weakening investor protections, and leaving traditional high yield investors struggling to achieve what they consider acceptable yields for the risks they are being asked to accept. Some describe themselves as “disappointed” and “disenchanted” with the market.
High yield investors speaking to GlobalCapital say that the extra demand from investors in corporate high grade bonds buying high yield paper has caused coupons on double-B issues to drop by between 70bp and 160bp, depending on the issue, with a corresponding yield compression down the credit spectrum.
In the past two weeks, payment-in-kind notes with low ratings of triple-C and second lien notes have been priced with coupons of mid-4% and low 5%. These kind of high yield bonds used to pay double digit coupons as recently as October.
Investor protection terms are also being weakened, with default events and weaker change of control language. Some bankers have admitted that borrowers asked for looser terms than they needed, because they wanted to avoid accepting more restriction than their peers.
To an extent, this how the market grows and changes. Abundant demand produces an issuer-friendly market, which gives way, when the market turns, to an investor-friendly market. Covenants loosen until they're forced to tighten again.
But the market will look different when the pendulum swings back: with a smaller stock of bonds than many expected (issuance has shrunk since its peak in 2015), and with an unbalanced rating distribution skewed towards the double-B space (more than 70% of the market by volume).
Traditional high yield investors, who have stuck by the asset class in good times and bad, will be more important than ever to get the market through this period. By then, the investment grade tourists, driven in by ECB distortions, will have departed.
So the market needs its core investor base, and, even in issuer-friendly periods, should seek to ensure they're looked after. High yield investors do not need cosseting from capitalism — but the dilution of terms must have a limit.