Azhar’s crunching credit – High yield past and present

The government bond gyrations of August returned with a vengeance in September with the 10-year US treasury up 47 basis points (bps) to end 4.57%, whilst 30-year yields were up 49bps to close at 4.69%.

The front end was little changed, up 1 bps, at 5.04% for the two-year bond. Spreads tightened initially into the sell-off before reversing that in the last week of September and ending broadly flat.

Key indicators

• High yield bonds outperformed investment grade bonds due to interest rate duration. Global high yield returned -0.67% and global investment grade -1.8%.
• High yield spreads widened to 444bps, 3bps wider on the month, after being 20bps tighter intra-month – CCCs were 18bps wider, Single Bs 1bps wider and BBs unchanged.
• Investment grade spreads – stay at 136bps, still close to the 129bps ytd low seen back in February.
• Contrary to consensus, investment grade bonds are now just at +1.05% returns ytd, well behind the +5.05% ytd return high yield markets have delivered.
• With over $22bn of new issuance in the US high yield market alone September was busy but the global high yield market continues to shrink with face value falling to $2,226bn (down $12bn from August and down $90bn ytd)

Area of focus – Liquidity

An area which often gets much focus is the illiquidity of high yield markets so its worth an occasional look at the data behind this:

• Trace high yield data, taken from the US high yield market, shows that trading volumes at 0.80% of the total market in size are just below median levels of 0.87%.
• Bid-ask spreads hit lows of 25c in the middle of 2021, before rising with the general fixed income sell-off to hit 49c in June 2022, these have been falling ever since and are currently at 31c (median 36c – calculated using Bank of America data from 2008).
• The data above aligns with our own anecdotal feel of the market – portfolio trading is something which has been on the rise in high yield markets and something which we think has broadened liquidity and reduced bid-offers further as the market has very much normalised over the last year.

A carpet roll-up unravelling – One to watch?

We spoke of accounting fraud allegations last month and this month we had ‘indications of fraud’ being found at Victoria plc by its own auditor. Victoria, an AIM-listed, levered ‘roll up’ of floorers has £1.2bn of debt and a £500m equity market cap so it certainly isn’t small, but it has a lot fewer options than Altice who we spoke about last month.

As with any fraud allegation the first question is about whether you can trust the numbers you are basing your investments upon, and this is where there remains a huge question mark over Victoria with only 33% of its profits having been fully audited and a specific scope audit procedure on some of the balance having uncovered this serious issue (albeit at a very small subsidiary). The company was quick to deny the allegations but with a capital structure that is unsustainable at current market level interest rates the onus is on the company to prove to the market its numbers are trustworthy.

Credit stories – New issues of high yield markets past and present

Worldpay, which is the electronic payments processor that sits behind much of the retail payments we make, returned to the high yield market after its disastrous acquisition by FIS was unwound. Worldpay was bought at a 20x EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation) multiple in 2019 ($43bn valuation) after years of successful growth and the business has unfortunately gone sideways ever since – so it returns to the high yield market via a fresh debt raise following a spin-off valuing the business at just $18bn (9.7x EBITDA). It’s a business that is easy to like as it is hugely cash generative and it came 4.3x levered via the issuance of $8.5bn of debt ($2.8bn of bonds and $5.7bn of loans). The jumbo $2.1bn tranche priced with a 7.5% coupon (8.5% in GBP). Worldpay is very much the modern high yield issuer – large, resilient, and proven.

In marked contrast we had Five Holdings issuing its debut bond. Five almost takes us back to the Mike Milken days of high yield investing when the debt market was open to the flamboyant and fabulous.

Five is a Dubai based Hotel & Entertainment operator which was looking to raise proceeds to buy the Pacha nightclub (and an associated hotel) in Ibiza. The debt was secured on the existing Dubai assets (but not the Pasha asset). This is a business which is quite new, quite niche, and in our view, unproven. We thought the risks seemed high for a single luxury operation but maybe we aren’t quite the demographic to fully understand the allure of high-end night clubs as the $350m 2028 issue priced at 9.375%.

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