High-Yield and Bank Loan Outlook - July 2014

  • FIXED-INCOME SECTOR REPORT

July 08 2014

Certain areas of leveraged credit are overvalued, particularly CCC-rated bonds and bank loans, but often some of the best profits come in the final phase of a cycle. With valuations frothy, we believe now is the time to start moving up in credit quality. Our analysis finds value in BB-rated and B-rated bonds and we are most positive on BB-rated and B-rated bank loans, where discount margins still trade wide of ex-recession averages.

High Quality High-Yield in a Maturing Bull Market

Certain areas of leveraged credit are overvalued, particularly CCC-rated bonds and bank loans, but often some of the best profits come in the final phase of a cycle. Low yields on U.S. Treasury bonds and European sovereign debt have kept the global search-for-yield theme alive and have lured more capital into U.S. credit markets, helping the ongoing rally in high-yield bonds and bank loans, which gained 2.4 percent and 1.2 percent (as represented by the Credit Suisse High Yield Index and Credit Suisse Institutional Leveraged Loan Index) in the second quarter of 2014, respectively. With valuations frothy, we believe now is the time to start moving up in credit quality. Our analysis finds value in BB-rated and B-rated bonds and we are most positive on BB-rated and B-rated bank loans, where discount margins still trade wide of ex-recession averages.

We remain concerned about weak structures, such as covenant-lite loans, payment-in-kind bonds and second liens — all growing trends amid increased leveraged-buyout activity. These trends are adding risk to an already richly valued high-yield bond market and are evocative of the weak debt underwriting standards that culminated in the 2008 financial crisis. However, a comparison of the current environment to that of 2006 and 2007 shows that while the market is certainly exhibiting signs of frothiness, we are still early in the speculative phase of the current cycle.

REPORT HIGHLIGHTS:

  • CCC-rated corporate bonds and CCC-rated bank loans are the richest groups in leveraged credit and should be avoided. Spreads have some room to run before reaching historically low levels, but now is the time to move up in credit quality.
  • Our outlook remains positive on BB-rated and B-rated bank loans. Their discount margins still trade wide of ex-recession averages and should tighten once the U.S. Federal Reserve begins raising interest rates.
  • We continue to emphasize relative value, deep credit analysis, and proper risk management — particularly as we enter the final stretch of the bull market. The value of these tools is highlighted by manager performance during the previous recession, when the bottom 20 high-yield managers underperformed the Credit Suisse High Yield Index by 10 percent, while the top 20 outperformed the Index by 8 percent, on average.

 



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This material is published for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. This material contains opinions of the author but not necessarily those of Guggenheim Partners, LLC, its subsidiaries or its affiliates. The author’s opinions are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.