Yield-starved investors have been diving into the “CCC” ratings bracket of bonds in the U.S. corporate debt market, or debt that sits only a few notches above default territory, in a desperate attempt to source income.
The combination of easy financial conditions and trillions in fiscal stimulus over roughly the past 12 months has limited the risk of defaults in high-yield corporate bonds, or “junk”-rated debt. But signs of exuberance in a market often associated with painful bankruptcies and loss-making companies also has investors trading the potential to earn income with much higher levels of risks taking.
“People are dipping down into some really scary credits in order to find that yield,” said Brandon Pizzurro, portfolio manager at Guidestone Capital Management, in an interview.
The worst-rated bonds in the sub-investment grade category have begun to trade well above pre-pandemic levels, underlining the avid demand for higher-income securities among money managers.
Falling rates and rising prices for CCC-rated bonds — the lowest rung in the high-yield universe before default — have pushed down the premium investors are paid on these risky corporate debt securities. As of Wednesday, the premium above Treasurys
slumped to 6.80 percentage points above the risk-free benchmark, down from 9.55 percentage points in January 2020. Bond prices move in the opposite direction of yields.
Overall yields in the U.S. junk bond market dipped to a new all-time low of 4.09% this week, down from a recent high of 9.2% in March 2020 at the onset of the pandemic in the U.S.
The slide in borrowing costs has spurred corporate treasurers presiding over fragile balance sheets to take advantage.
CCC-rated issuers, such as Party City Holdings
and the private oil drilling company Great Western Petroleum unloaded new debt this week, suggesting a deterioration in the quality of the high-yield bond market.
Party City borrowed $725 million through 2026 at 8.75% to repay a loan due next year, according to Bloomberg. Great Western borrowed $235 million through 2025 at an interest rate of 12% to help pay down existing debt, the company said.
High-yield issuance so far has risen to $71.4 billion, up from $60.8 billion over a comparable period, according to BofA Global Research.
But some investors say the focus on the worst-quality debt obscures the changing composition of the overall sub investment-grade corporate debt sector, which has been slowly tilting toward higher-rated issuers, partly due to defaults of struggling companies last year and the avalanche of downgrades among high-grade corporations into “junk” during the pandemic.
Specifically, the highest “junk” category of BB-rated issuers now occupied 55% of the market, up from the historical average of around 45% to 48%, based on a high yield index compiled by Bloomberg.
“In part, the evolution has to do with the worst-rated companies restructuring or leaving the market,” said analysts at Janus Henderson Investors.
Steven Ricchiuto, chief economist at Mizuho, also said metrics of credit distress have fallen dramatically thanks to the Fed’s interventions and it temporary emergency lending facilities that backstopped corporate debt markets.
The S&P distressed ratio is now at 5%, down from 7.6% in November. The distressed ratio measures how many bonds within the high-yield universe are sporting yields above 10%.