Investors shun riskiest US corporate bonds on default fears

The riskiest US corporate bonds have come under fresh pressure this year, setting them apart from a rally across broader debt markets as investors remain fearful about stop-start access to funding and deepening distress for low-grade borrowers.

Triple C-rated US bonds — the bottom rung of the credit quality ladder — are yielding 13.6 per cent on average, according to data from Ice BofA, up from just over 13 per cent at the end of 2023. Rising yields reflect falling prices.

In turn, the spread — meaning the premium that those lowly-rated borrowers must pay to issue debt over the US Treasury — has ballooned to 9.28 percentage points from 8.51 per cent in late December.

Those moves mark a divergence from a rally across higher-quality credit markets in recent weeks that has fuelled a wave of debt issuance. Investment-grade borrowers posted a record January for bond sales, while high-yield or “junk” volumes reached a two-year high, as finance chiefs took advantage of a drop in yields to borrow at more attractive rates.

Even after new US inflation data on Tuesday came in stronger than expected for January, awakening concerns over interest rates remaining higher for longer than previously anticipated, overall credit spreads were little changed. High-grade pharma group Bristol Myers Squibb sold $13bn of debt on Wednesday.

Investors and analysts said that the disparity between the highest- and lowest-quality bond spreads reflected persistent worries over very risky companies losing access to funding, forcing them further into distress — a scenario that could spark more defaults.

“Our view is that for reasonably high-quality businesses, there will be interesting ways to access capital,” said Ed Testerman, partner at investment management firm King Street Capital. “[But] for the lowest quality companies, there will be fewer options at their disposal, which may drive more defaults.”

The average spread for double B-rated bonds — the highest rung of the junk credit world — stood at 2.01 percentage points on February 15, lower even than levels seen late last year when demand soared for corporate debt, after the Federal Reserve signalled that it would start cutting borrowing costs in 2024.

The difference between lower-rated and higher-rated junk bond spreads “suggests that the market believes default rates and recovery rates are going to be much higher, and lower, respectively in the triple C market”, according to Testerman.

Some highlighted that there had been minimal issuance of triple C-rated debt in recent years, leaving the index of low-grade bonds highly concentrated around a small cohort of companies.

“It’s not like triple C is a diversified index,” said Jeremy Burton, US high-yield and leveraged loan manager at PineBridge Investments. “It’s heavily skewed towards stuff . . . that’s been downgraded over time from single B.”

Triple C issuers listed on Ice BofA’s index include Dish, the TV group that recently merged with EchoStar. EchoStar subsequently proposed a series of “distressed exchanges” — a transaction that typically involves investors being asked to swap out some of their debt holdings for assets of lower value.

Other bonds with triple C ratings were issued by cyber security groups McAfee, Cloud Software Group and healthcare services company LifePoint Health.

S&P Global Ratings said in a report on Thursday that triple C borrowers would “contend with weak cash flow and elevated interest expenses this year”, while “defaults in 2024 [would] largely come from consumer-facing sectors, such as consumer products and media and entertainment, as well as the still highly leveraged healthcare sector”.

Technology, media and telecoms companies made up almost a third of the entire $174bn triple C index as of February 15, while healthcare made up more than a tenth.

Renewed focus on potential defaults among the riskiest corporate bonds comes as investors have had a big rethink about the outlook for US interest rates boosted by strong economic data, including the latest blockbuster jobs figures that punctured hopes of a sharp fall in borrowing costs in the world’s largest economy.

Markets are now pricing in three or four quarter point interest rates cuts from the Fed this year from the current target range of 5.25 to 5.5 per cent, compared with six cuts priced at the beginning of the year, adding pressure to companies that need to refinance their debt in the next couple of years.

For PineBridge’s Burton, “the market feels really good about overall high-yield credit spread risk right now”. But investors are “very wary of the bottom 5 or 7 per cent of the market, where there is . . . material default risk over the next two years”.

“The market is being really punitive on that stuff.”