Borrowing Among Junk-Rated Firms Slows to a Trickle
A combination of higher funding costs and ratings upgrades trims the supply of high-yield bonds
Companies with speculative-grade credit ratings have slowed their pace of borrowing, illustrating how rising interest rates have upended the pandemic-driven boom.
Junk-rated companies have raised roughly $74 billion so far this year, just a quarter of the nearly $300 billion from the same period last year, according to Refinitiv.
That has led to an $80 billion drop in the net supply of high-yield bonds, a figure that is expected to grow to $130 billion by the end of the year, according to Goldman Sachs Group Inc. GS 0.06%▲ Such a fall would mark the biggest annual decline on record.
Yet the market isn’t ringing alarm bells.
The extra yield investors demand to hold junk bonds over U.S. Treasurys has risen to 5 percentage points from 3.1 points in January. That is well below the recent high of 11 points in March 2020.
Historically, the spread averages between 3.75 and 4.5 points, according to Seth Meyer, portfolio manager at Janus Henderson Investors.
“The market is implying some level of stress, but no reason to panic,” he said.
High-yield bonds trading in the secondary market still total a lofty $1.4 trillion, fueled by the nearly $900 billion in new junk bonds that came to the market in 2020 and 2021. Back then, easy monetary conditions during the Covid-19 pandemic allowed companies to raise cash cheaply and reduce their overall debt.
Higher funding costs are now discouraging some companies from issuing debt as the Federal Reserve rapidly raises interest rates and tightens financial conditions. The yield-to-worst, or the lowest rate an investor can expect to earn short of a default, on the USD High Yield index recently hit 8.62% before easing to 7.92% last week. That is up sharply from 4.2% at the start of the year.
Ratings upgrades have contributed to the declining supply as well. Roughly $64 billion of bonds have migrated into investment-grade territory from speculative status, while only $19 billion of bonds that were investment grade have been downgraded to junk.
Accelerating inflation and higher interest rates began to put pressure on speculative bonds at the start of the year when stocks and bonds fell in lockstep. Investors pulled about $45 billion from high-yield bond funds in the first half, the highest two-quarter total since at least 1992, according to Refinitiv.
So far this year, high-yield bonds have fallen 10%, while investment-grade-rated bonds have dropped 14%. Despite the worrying economic backdrop, junk bonds outperformed their higher-rated peers this year.
“This is the best high-yield bond market in over two decades, in terms of credit quality and liquidity positions” said Lotfi Karoui, chief credit strategist and head of credit research at Goldman. “This is not an old-fashioned, corporate-led recession. Fundamentally, the high-yield market is in good shape.”
Bonds rated double-B, which are one notch below investment grade, comprise 53% of the high-yield space. That is up 10 percentage points from a decade ago, according to the Intercontinental Exchange ICE -0.14%▼. Bonds in the lowest category, triple-C, have dropped to just 11% of the total high-yield market, near historic lows.
Energy companies, the largest constituents of the high-yield universe, weighed on the asset class in previous years. But macroeconomic drivers such as the Russia-Ukraine war and a resurgence in demand for oil sent energy stocks soaring in the first half of the year, even as the broader market dropped sharply.
“Energy firms have deleveraged aggressively, and many posted record performances this year,” said John McClain, portfolio manager for high-yield and corporate credit strategies at Brandywine Global. “They are far more focused on returning cash to shareholders now than in the past.”
Callon Petroleum Co. CPE 6.67%▲ was one of the few high-yield companies to issue debt in the second quarter. The Texas-based oil and natural-gas company issued a $600 million bond at 7.5% last month to help fund redemptions of existing debt due to mature soon. The securities redeemed include a bond that paid 6.125% due in 2024, and a riskier so-called second lien loan that paid 9%, due in 2025.
Pointing to an improved leverage profile, Fitch assigned B-plus ratings to that issue and the company’s previous issue, a higher mark than Callon’s long-term B rating.
“We were able to lower our overall interest-rate expense and improve our long-term debt structure,” said Kevin Smith, director of investor relations at Callon Petroleum.
Elsewhere, Delta Air Lines Inc. DAL 0.19%▲ recently unveiled a $1.5 billion tender offer to repurchase several bonds due over the course of the next few years, with coupon rates ranging from 3.800% to 7.375%.
“Delta Air Lines’ tender is focused on higher coupons, but shows there is still a lot of balance-sheet maintenance to be done in the high-yield space,” said Mr. Meyer of Janus Henderson Investors.