5 May 2015, Stockholm, Sweden | News
The Nordic high-yield market was rocked in 2014 in a way we have not seen since the Lehman crash. The falling oil price was the crux, and it became clear how large a share of the Nordic market is represented by Norwegian high-yield companies in the energy sector. It also made visible the lack of liquidity in many outstanding bonds.
Despite more stable oil prices and improved risk appetite during the past quarter, Norwegian high-yields are down 6.7 percent in the past 12 months. This compares with European high-yields, which are up 6.3 percent, and American high-yields, which are up 2.5 percent over the same period. In Europe as a whole, the energy sector represents a very small portion of outstanding bonds while in the US it accounts for about 17 percent of the high-yield index. There is unfortunately no Nordic index to compare with. Given the large proportion of the high-yield market issued in the Norwegian oil sector in recent years, however, it is easy to assume that a Nordic high-yield index would be unlikely to have managed a positive return.
Nordic Trustee recently released statistics showing that of the outstanding issue volume of Nordic high-yield bonds, Norway accounted for about 65 percent in the period 2006-2014. The bulk of these are issued in the capital-intensive oil sector. In an asset class with relatively poor liquidity, the result of several investors selling simultaneously is that the exit door quickly becomes crowded. This makes it necessary for investors to keep a cool head and distinguish between purely flow-driven sales (sales as a result of outflows from funds) from actual deterioration in credit quality. The former becomes clear when credit spreads widen in sectors that are far removed from oil and oil services. A purely flow-driven widening therefore implies a very good buying opportunity, while investors should be more careful when it occurs as a result of increased credit risk.
The bonds that were traded downward due to outflows last year have, as expected, rebounded and have now made a comeback as capital outflows have reversed to inflows. If we dig deeper into the Norwegian high-yield market, we can observe that oil producers, namely those with direct exposure to the price of oil, are down 14.8 percent over the past 12 months, and the oil services sector is down 12.6 percent. With a decline of this level, we have to ask whether credit spreads have now reached an attractive level. The answer is unfortunately ambiguous.
Today's credit spreads give an implicit default rate of around 10 percent. This may sound high, but in comparison approximately 25 percent of outstanding Norwegian high-yield bonds went into default in 2009. The levels will probably not reach such highs this time, partly because the statistics include a couple of really big defaults (like the PetroMena bonds), and partly because banks are stronger today which reduces the refinancing risk. Moreover, the large loan maturities are further in the future, towards 2018–2019, which also limits the risk of mass defaults in the near future.
With that said, the sector is a minefield so even if credit spreads generally narrow, there are several mines that could explode if we take the wrong steps. Investors dipping their toes in the sector should seek companies with visible cash flows and strong owners. Although the unrest in Yemen and closed US oil rigs have helped to stabilise oil prices, we should not expect these to return to the levels seen a year ago. This means that companies that failed to earn money at those levels are in trouble. They will require capital injections from owners and there will be negotiations with bondholders.
By investing in funds that are traded daily, you hand over the issue of liquidity to the fund manager. Also, be aware of the diversity of your savings. In order to avoid large fluctuations, it is important to invest in funds that are well diversified both geographically and among sectors.