With weak same store sales and countless store closures announced over the first quarter, retail has been in the spotlight as an area of mounting weakness. So far this year we have seen bankruptcies from Payless Shoes, H.H.Gregg, Eastern Outfitters, BCBG Max Azria and Wet Seal, while Sears had “going concern” language in their year-end 10K filing. Should some of the tax initiatives like the border tax actually see the light of day, that will do further damage to retailers.
Certainly retail isn’t as prominent in the high yield indexes as energy was going into its downturn (thus we would not expect to see the broader high yield bond and loan market pressure/negative contagion that we have seen with oil), but it is still an important industry group and investors should be cautious as to what they hold in many of the passive products. Retail is approximately 4% of the high yield bond index and 6.5% of the floating rate loan index.1 Retail is undoubtedly under pressure and we would expect see further bankruptcies in this industry, just as we saw a spike in energy-related bankruptcies last year (though we do continue to expect total default rates for the broader high yield bond and loan market to remain well below historical long-term averages). For instance, the retail sector has the highest yield to maturity and yield to worst of all the industries in high yield bond index, by a wide margin, and the spread for the retail industry is nearly 400bps above the average spread for the entire high yield bond index of 457bps,2 indicating to us the stress we are already seeing in this industry.
We have talked time and again about the value of active management in terms of what you don’t own. As active managers, we are not forced to own something just because it is part of an index or the broader higher yield market. Not ever retailer is destined for a significant security price decline or bankruptcy, but there are certainly many that we believe should be avoided. With our active strategy, we can look at the fundamentals of a credit and determine our view of its prospects and whether we want to own the name or not. We aren’t a lender that is forced to make a loan to every company that wants one, rather we are able to be selective and choose to whom and what we want to lend.