High yield spreads plummet as stocks rally

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Suddenly, investors aren't so scared of high yield debt.

South of the border, high yield spreads over Treasuries blew out when the latest bout of European fears erupted this past spring and investors grew more cautious. Lately, though, they've plummeted, according to Bespoke Investment Group , hitting a new low for the year at 568 basis points above Treasuries. The previous low was about 580 basis points.

As Bespoke points out, this trend is typical. "When the equity market is rallying, spreads decline (investors perceive less risk in holding lower quality debt). Conversely, when equities fall, spreads rise (investors perceive more risk in holding lower quality debt)."

But for those who are still jittery, a new report from Moody's Investors Service notes that investors in Canadian high yield debt are better protected than their American counterparts because Canadian dollar high yield bonds have stricter covenants. The results came from a study of 29 Canadian high yield issues.

Although it was hard to arrive at one simple explanation as to why they do, Moody's concluded that "perhaps the relatively small number of investors in the developing domestic [Canadian] market gives them more influence over covenant structures than investors in the more developed cross-border market."

In scoring, Canadian high yield bonds faired better because their covenants limit the risky investments that companies can make outside their core businesses; they limit the amount of leverage that can be added to the balance sheet; and they limit the amount of secured debt that the companies can add that would subordiante their bondholders access to assets in the event of a default.

Postmedia Network Inc.'s bonds had the best covenant rating among Canadian high yield issues, while MEG Energy Corp.'s had the worst.

However, Canada's preferential status over U.S. high yield bonds isn't really anything to get too giddy about. Moody's found that our covenant quality is weaker than the following regions: Asia, emerging markets and Africa, and Latin America.

Canadian firms have raised $9.2-billion in non-financial speculative-grade bonds that issued in Canadian dollars since 2010. About $20-billion has been raised in cross-border bonds issued in U.S. dollars.