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Yield-to-worst in junk bond market hits record low
Wed, Mar 13 16:47 PM EDT

By Joy Ferguson and Rachelle Kakouris

March 13 (IFR) - The yield-to-worst in the US high-yield bond market has fallen to a record low average of 5.56% this week, as investors flock to higher-yielding but riskier products.

The 5.56% level, reached on the Barclays High Yield Index on Tuesday, was below the previous record of 5.61% set on January 24.

With interest rates hovering around record lows, investors have found themselves rushing down the credit ladder in search of bonds offering more return - and more risk.

CCC rated bonds - the riskiest investments at the very bottom of the credit spectrum, just one notch above default level - have rallied the most.

"It's definitely risk-on behavior, where you are trying to get exposure to the most yield possible," said Drew Mogavero, head of US high-yield trading at Barclays.

"The safer segments of the market, BBs, have rallied to pretty low-yielding levels," he said. "So people are looking out to CCCs and other higher-yielding names."

Bond yields and prices move in opposite directions. As investor demand has driven up prices, yields have tumbled. Yield-to-worst indicates the lowest potential yield on a bond without the issuer defaulting.

LOWER ALL OVER

Broken down by ratings, the yield-to-worst on the Barclays Double B index is also at its lowest ever (4.24%), as is the level on the Triple C index (7.43%).

But Barclays analysts said that the Triple C number is 5.9% if the very highest yielding CCC bonds - those with a yield-to-worst of 10% or higher - are taken out.

"That just tells you that the CCC index, excluding the real equity-like paper, yields pretty low levels," said Mogavero.

Bonds trading with a yield-to-worst of 10% or more account for 24% of the CCC index by par amount.

Some examples include Clear Channel Communications, Caesars Entertainment, First Data Corp, Albertson's and Verso Paper.

This higher yielding equity-like debt typically falls into one of two categories: large pre-crisis LBOs that have not been able to de-leverage, or businesses that are facing secular challenges, Barclays strategists said.

The only segment of the market that didn't close at a record low on Tuesday was the Single B index, which is 5.46% versus the record low of 5.39% set on January 24.

Year to date, the US high-yield market has returned 2.47% overall.

PROCEED WITH CAUTION

Hozef Arif, senior vice president and portfolio manager at PIMCO, warned that lower yields provide less compensation to investors and leave less room for error.

"Future performance will be determined not just by what you do own, but also by what you don't own," Arif said. "Credit selection will become increasingly important."

He said that high-yield investing opportunities can be found in stressed European companies where asset protection is good, as well as in well-structured LBOs, single B industrial corporates and certain improving Triple C credits - albeit with higher risk, he says.

In addition, Arif said that some remaining opportunities may lie with certain higher quality names where there is a catalyst like M&A, or candidates with potential for upgrades into investment grade ratings.

The strength in the high-yield market has pushed many callable bonds back above their call prices.

Arif said that of the 67% of high-yield bonds that are callable, 83% are trading to the call date, according to the BofA Merrill Lynch US high yield index as of February 28.

"Now it's not just about credit selection, it's also about convexity selection," said Arif.

MODEST PACE

So far this week, the high-yield market has seen US$2.69bn in US dollar issuance price from seven issuers, including non-US entities.

That's a modest pace, and bankers say much necessary refinancing has already been taken care of earlier in the year and late in 2012.

However, another roughly US$3bn is expected from an assortment of issuers later this week.

Among the larger deals, McGraw-Hill Global Education Holdings is looking to raise US$1.05bn in eight-year non-call three senior secured notes via Credit Suisse, Morgan Stanley, BMO, Jefferies, Nomura and UBS joint books.

HJ Heinz will provide extra supply with a US$2.1bn offering, rated B1/BB-, as part of its LBO by Berkshire Hathaway and 3G Capital.

The 7.5-year non-call two second lien senior secured deal was officially launched on Wednesday afternoon, and is expected to price next week or early the following week. The roadshow will begin on Thursday.

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