Junk borrowers face tough months
January 14, 2014
OGX’s default, increasing benchmark rates and a turning macroeconomic cycle are set to make borrowing more difficult for sub-investment grade companies this year, say portfolio managers
High-yield credits are poised for months of turbulence as investors demand more compensation for their risk amid rising borrowing costs and as commodity prices and economic growth moderate across the region.
This comes at a time when fund managers are growing more sensitive to the hazards of investing in emerging market high-yield debt, following last November’s high-profile bankruptcy – the largest in Latin American history – of Brazilian oil firm OGX.
“This case in a relatively short period of time will establish how much of a premium one should ask for investing in emerging market corporate debt, taking into account weaker legal framework,” said Polina Kurdyavko, senior portfolio manager at BlueBay Asset Management, which is not an OGX bondholder.
“We always knew the framework was weaker [in emerging markets], but it was always difficult to assign a spread pickup,” she added.
OGX’s troubles are “clearly negative” for perceptions of the asset class, said Darin Batchman, a portfolio manager at Stone Harbor Investment Partners, which manages $63 billion in assets.
While “the last few years have allowed [high-yield borrowers] access to the capital markets and long-term financing at attractive rates,” they are now “subject to rising interest rates, as are companies all over the world,” Batchman said.
But he added that most major companies in the region nevertheless had solid fundamentals. “The majority of Latin American corporates are very solid, well positioned, and protected from FX moves,” he said.
Robert Abad, portfolio manager at Western Asset Management, said that although benchmark rates are likely to rise this year, they will remain low from a historical perspective. Emerging market high-yield assets will therefore retain their appeal, he added.
Abad nevertheless called attention to a range of factors that will determine investor demand for high yield credit.
“Jurisdictional risk is still a very opaque area when investing in emerging markets simply because we haven’t seen more natural cycles in the past five to 10 years which would have aided in the evolution of bankruptcy and restructuring frameworks,” he said.
That opaqueness means that issuer-specific factors — business model, operating record, and management experience — will tend to determine risk premiums, he said. Investors must research firms thoroughly to avoid ending up with defaulted paper.
“People forget that bankruptcies and restructurings can be protracted affairs. This is important, as growing legal costs over time could make the ‘all-in’ recovery value much lower than what was initially anticipated,” Abad said.
Default rates among high-yield companies in Latin America and the Caribbean, meanwhile, are on the rise, reaching 2.8% in mid-2013, according to Standard & Poor’s. That was up from 2.45% a year before and well above the overall emerging market default rate of 2.3%. LF
See also: High-yield bonds: Balance of power