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Signs of ‘Pure Froth’ Emerging in Credit Markets, Cantor Says

Joanna Ossinger and Katherine Greifeld

(Bloomberg) -- Warning signs are starting to flash in U.S. credit markets, according to Cantor Fitzgerald LP.

Companies sold around $13 billion of junk bonds this week, the most in more than two years, according to data compiled by Bloomberg. Risk premiums for the securities have dropped more than 1.5 percentage points this year on average, and investors aren’t getting paid much more to buy junk bonds instead of investment-grade, by some measures.

Relatively risky junk-bond sales like a $300 million offering from Core & Main LP, a sewer and water supply distributor, show that the credit markets keep inflating, Cantor Global Chief Market Strategist Peter Cecchini wrote in a note Sept. 12. Companies are taking on more debt, he said.

“We are starting to see signs of pure froth,” Cecchini wrote, adding that "many deals have been priced to perfection.”

PIK Notes

Core & Main’s new bonds allow the company to delay interest payments, a feature known as “payment in kind toggle.” Securities like that often grow more popular when money is pouring into debt markets. In this case, the bonds will boost the company’s borrowings relative to an earnings measure and increase its interest payments relative to that income metric, Cecchini wrote. Core & Main cut the size of the offering to $300 million from $400 million, and increased the coupon to 8.625% from 8.375%.

Companies’ debt loads are broadly getting higher, Cecchini wrote. A greater share of high-yield companies have obligations equal to more than seven times a measure of income known as earnings before interest, taxes, depreciation and amortization, he wrote, citing data from LCD. A higher proportion of companies have Ebitda equal to less than 1.5 times their annual interest expenses.

Meanwhile, U.S. corporate bonds have rallied, with high-yield notes gaining about 11.6% this year, accounting for both price gains and interest. Risk premiums for the securities, or spreads, narrowed to 3.65 percentage points on average on Thursday, from 5.26 percentage points at the end of last year. The average spread for a U.S. BB rated company -- the highest junk-bond rating -- earlier this week was just 0.55 percentage points more than for a company with the lowest investment grade rating, the narrowest gap in a decade.

Uncertainty about stock market prices, as measured by equity market volatility, is high relative to corporate bond spreads, Cecchini wrote. He doubts the rally for junk-bond spreads will continue.

“It’s unclear what the catalyst for a severe sell-off might be, but we don’t expect more spread compression,” he wrote.

--With assistance from Gowri Gurumurthy.

To contact the reporters on this story: Joanna Ossinger in Singapore at jossinger@bloomberg.net;Katherine Greifeld in New York at kgreifeld@bloomberg.net

To contact the editors responsible for this story: Christopher Anstey at canstey@bloomberg.net, ;Andrew Monahan at amonahan@bloomberg.net, Dan Wilchins, Nikolaj Gammeltoft

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