Kames’ Milburn: Can high yield finally stop sowing seeds of its own destruction?

A shift to focus on refinancing existing debt, coupled with a tightening up of bank lending, could keep the high yield default cycle much more subdued in the next few years, Kames Capital’s Phil Milburn has said.
 
While expectations are slowly mounting that high yield defaults may start to accelerate as the interest rate environment finally starts to normalise, Milburn said there had been a number of developments in the high yield space which could potentially make the sector more durable this time around.
 
In particular Milburn, manager of the £1.5bn Kames High Yield Bond fund, said a 70% decline in leveraged loan supply in the first four months of 2015, as well as new rules restricting what banks can underwrite, were very healthy developments which could limit a spike in defaults.
 
“In previous cycles, high yield has sown the seeds of its own destruction by lowering standards too far during the bull phase, before subsequently suffering higher default rates in the three big downturns; the junk bond crisis, the TMT bubble and the LBO boom/credit crunch,” he said.
 
“This time around defaults have remained low, and while any serious downturn may well not happen for a few years, I see the decline in leveraged buyouts and the increased scrutiny and regulation of banks as a key factor in keeping the figure within the range we have seen over the last five years.”
 
Default rates have been subdued since the spike in 2009 when they reached double-digit levels, remaining below 3% since then. Milburn said while some companies will inevitably go to the wall as the current cycle progresses, this more disciplined era could prevent defaults returning to credit crunch levels.
 
“Mistakes will still happen and companies will become obsolete all the time, but if the market can maintain discipline then the default rate peak in the next downturn will be lower than on previous occasions,” he said.
 
Elsewhere, the manager said the recent jump in government bond yields was unlikely to be the start of a prolonged shift away from fixed income.
 
“Is the recent unwind in bond yields the beginning of the great re-attachment to fundamentals? We think not. We are still operating in a rigged world where central banks are keeping yields artificially low,” he said.