Three in Five Podcast

Episode 7: Three high yield market questions for John

Steve sits down with John Fekete, Head of Capital Markets at Crescent Capital Group, to discuss valuations, issuance and default rates.

Steve Peacher: Hi everybody thanks for tuning in this is Steve Peacher I’m President of SLC Management, and this is the latest episode of “Three and Five”, in which we ask three questions of our experts around SLC Management. Today I'm really pleased to have John Fekete with me, John is the head of Capital Markets at Crescent Capital. John thanks for joining.

John Fekete: Thanks Steve.

Steve Peacher: John you oversee a group that invests in the high yield market, among other things, and spreads in that market have rallied a lot over the last year, maybe more than people would have expected a year ago, as the pandemic started. What do you think about valuations today, do you think that rallies gotten ahead of itself, and you know, do you think there's value in the high yield market given today's spreads?

John Fekete: Well Steve that's a question we're getting a lot these days and I always start with the fundamentals and the fundamental picture these days is very solid. GDP growth is expected to be seven or 8%¹ this year so that is very supportive of credit, we see very few companies, these days, that are stressed or even at risk of default. So, all of that, in my mind is supportive of value-oriented asset classes like high yield bonds. Our evaluations stretch, there they're certainly not as exciting as we would like to see, and I do hear lots of people anchoring their valuation to where things were before Covid. I just point out that there really is no historical precedent for the current market, and by that I mean investors have never seen this level of support - fiscal support monetary support - for the U.S. economy, so I’m not sure if anchoring to where we were before Covid, it is the right way to look at it. Could we have a pullback? Sure, but to me like to my thinking it's likely to be short lived in shallow given just how much liquidity is in the system.

Steve Peacher: You know the new issue markets there's a lot of new bonds being issued and I think that's the sign of a healthy, high yield market generally. You know, recently, and you and I were talking about just last week, you know it was notable that a big high yield issue came to market for a company that was going to use the proceeds to buy Bitcoin so that you know, the question I think is when you look at the level of issuance and the uses of proceeds, how do you feel about the new issue market and do you think it's a sign that the market starting to get a bit frothy.

John Fekete: I agree with you Steve, I think that it is a sign of a healthy market right when borrowers and lenders can come together and find a way to fund growth M&A, so I don't take it on its face that it's negative, we certainly have seen robust corporate bond issuance, no question. Particularly last year and, and I would say that's been beneficial. Why? Because it's allowed borrowers to shore up their liquidity, to defend against the impact of all the Covid shutdowns and disruption. Long term can certainly be a cause for concern that's something we watch very closely. But the good news in that regard, is that low interest rates make it relatively cheap for these high yield borrowers to service and refinance their debt, so for now I think it's a healthy dynamic.

Steve Peacher: You know one thing that people track in the high yield market, of course, is default rates and I think going back a year at the beginning of the pandemic people would have expected high yield default rates that would be a lot higher than they actually are today. And I think that's because the economy, you know was stronger than people might have expected. But I also think, and this is a question that debt levels, you know that levels have gone up as companies have borrowed to maintain liquidity. Do you think we could see a lagged credit effect where you know the credit stress actually manifest itself in a couple years because companies are exiting the pandemic, not with high default rates but with higher debt levels than the entered the crisis?

John Fekete: Well it's definitely true that the corporate default rate is not nearly as bad today is people feared last year. I remember second quarter, third quarter last year, a lot of strategists were saying that defaults would hit 10 or 15% of the high yield market, which would be a huge number, and instead the default rate peaked around six or 7%². So, definitely elevated last year, but much lower than feared. I think you know we're seeing the opposite dynamic this these days, fewer defaults because revenue and profit growth is accelerating, balance sheet repairs underway. In fact ratings upgrades have been outpacing downgrade. So I'm not expecting another wave of defaults, not anytime soon. The fact that markets were accommodating like we talked about a moment ago that record new issuance allowed these borrowers to refinance their maturities and push them out four or  five years, so I think, pretty much smooth sailing from a default perspective for the next couple of years, the wall will be in four or five years when all these new issues begin to mature.

Steve Peacher: So, I think the overriding theme I'm hearing from you is fundamentals are pretty strong backing the market today and that should continue for some time. So, one more question unrelated to high yield market, I know you're a wine enthusiast So my question is, if you look at the wine market from an investment standpoint, you know what's being paid for top quality wines today, how do you feel about the wine market as a market, and you know, is this a good place that somebody might want to consider putting their money, or is it overvalued?

John Fekete: Well, similar to other stores of value like artwork or jewelry, NFTs, Bitcoin, wine is definitely benefited from that and all the liquidity out there. It is a scarce resource, right, there's only one vintage every year, and once that vintage is gone, you know it's on to the next and are a lot of vagaries around weather and climate and such. So it's a tough business, but no, no question, similar to other assets it's appreciated a lot. It's really hard to find value, again probably similar to other asset classes as well. There aren’t too many value-oriented wines. There was a time when California wines used to be that the value in the market and that's not the case anymore, a good cabernet cost over $100 bucks. So you got to do your homework, if you want to find a good deal.

Steve Peacher: Okay, just like any other market. John, thanks a lot for taking the time and thanks everyone for listening into this latest episode of “Three in Five”.

John Fekete: Thank you Steve for inviting me to do this.

¹ https://www.businessinsider.com/economic-outlook-gdp-growth-biden-stimulus-infrastructure-plan-recovery-goldman-2021-3

² https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/us-leveraged-loan-default-rate-expected-to-peak-at-6-6-8211-lcd-survey-60554195#:~:text=For%20year%2Dend%202020%2C%20loan,twelve%20months%20ending%20September%20202

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