Playing Chicken In The High Yield Market

  • Oct 21, 2020
  • Zero Hedge

When Covid-19 sent corporate bonds into a tailspin in March, it set in motion a game of chicken at overleveraged companies. Like James Dean and his rivals in the movie Rebel Without A Cause, the companies and their bondholders were like drivers racing towards a cliff.

Should investors accept a painful write down on their bonds in order to keep companies alive and avoid even worse pain later on? Or should they call the company’s bluff and insist on full repayment of their debt?

The Risky Finance corporate bond tool provides a ringside seat on some of these scenarios. Take the sector whose spreads declined the most on average since March – Oil & Gas. Investors in high yield bonds who bought that month have seen returns of 300% or more, while investment grade bonds have provided a 30% return since then.

But there was also survivorship bias lurking behind this rosy picture. The latest data doesn’t include the 19 US oil and gas producers in the iBoxx index that have filed for bankruptcy since the lockdowns began, defaulting on $21 billion of bonds. We’ve created a new tool to track this, looking for issuers that have left the index between two specified dates. This isn’t a surefire predictor of bankruptcy – a company might buy back its bonds for example – but for high yield issuers it comes pretty close.

In Oil & Gas, the biggest vanished issuer since March is Argentina’s YPF, which had $6 billion of dollar bonds in the index at the start of the year. That was before a plunge both in the price of oil and the value of the Argentine peso, prompting a fall in the price of the bonds to 50 cents on the dollar before they left the index in April. Today, YPF might not be technically in default but it is close to it.

Then there is the list of bankrupt US energy sector issuers such as Chesapeake, California Resources, Valaris and Whiting Petroleum, the last of which emerged from Chapter 11 proceedings in September after creditors agreed to slash debt by $3 billion.

There is a fine line between these companies and those that clung on, such as Gulfport Energy. After its bonds earned 300% returns between March and September, Gulfport announced on 15 October that it would enter into a 30-day grace period on $650 million of senior unsecured notes. Similarly with drilling company Transocean, which seemed to have staved off trouble with a refinancing only to have it opposed by some bondholders who now threaten to tip the company into bankruptcy.

The second biggest sector hit by bankruptcy during the pandemic is Telecommunications, but here the victims are two large issuers in trouble long before Covid arrived: Frontier Communications and Intelsat Jackson, which collectively had $17 billion of bonds go into default. What the pandemic did was make the restructuring faster and more brutal for investors than it might otherwise have been.

The third worst performing sector in terms of excluded bonds is more predictable given the pandemic: Travel & Leisure. The companies that have left the iBoxx index this year include Hilton Hotels, Latam Airlines, Hertz car rentals and UK pub chain EI Group among others. If they’ve not actually filed for bankruptcy they’re in the waiting room.

If we change our snapshot to the last two months, it is interesting to look at the best performing travel & leisure company still in the index – AMC Entertainment Holdings, which owns 1,000 cinemas, mostly in the US. A mainstay of the junk bond market, B-rated AMC traded at par just three years ago, but has been hammered by coronavirus. So why did the average yield on its bonds tighten by 18 percentage points in the last two months?

When the pandemic hit, AMC had $1.6 billion of bonds outstanding, with coupons of between 5.75-6.15%. The prices of these bonds plummeted, reaching 25 cents on the dollar in May. But AMC succeeded in restructuring some of this debt, paying investors 75 cents for the old bonds, and issuing new ones with a coupon of 10% in addition to issuing new shares while reducing leverage.

At the end of September, with the pandemic showing no sign of easing up, the new AMC bonds fell to 74 cents on the dollar. The movie industry may never recover from the coronavirus and investors must know it – but AMC is hanging in there. It’s a similar story with the second best performer in Travel & Leisure, Germany’s Tui Group, rated CCC. Tui recently assuaged bondholders by announcing a rights issue, prompting a 10% decline in its equity price (already two thirds below its pre-pandemic value). In this year’s bond market, investors are seldom happy unless somewhere, a shareholder is crying.