This year has seen me dive into a variety of topics, but as the year draws to a close, one area that I have not given much attention is high-yield debt – and there are reasons, too. With a rating of below investment grade, high-yield bonds have proven attractive to investors in the current, ultra-low interest rate environment: global government bond yields are low, and in some cases negative, so high-yield bonds can offer investors juicier yields in exchange for taking additional credit risk.
In both Europe and the US, the two largest high-yield markets, high-yield corporates have seen strong revenue and earnings growth, as well as improving coverage ratios. This means that companies’ ability to service their debt, and pay back the money they owe, has improved. This in turn has driven down US and European default rates to incredibly low levels, with a decline of 1.2 per cent for the US and 0.3 per cent for Europe.
With so much of the high-yield market depending on companies’ ability to pay back the money they have borrowed, we can use several indicators to assess current conditions in the space. First, we can look at the ratings breakdown of new issues over time. Approximately 50 per cent of European high-yield issues have the highest non-investment grade rating of BB, compared with fewer than 10 per cent of new issues in 2008.
In addition to improving in quality, the European high-yield market has transformed itself from a largely junior market a decade ago, dominated by private company debt issues, to a predominantly senior secured market. The ‘maturity wall’ shows the value and quality of bonds due to mature in the coming years. This illustrates to investors if there are any refinancing risks in the market, where bond issuers pay back their maturing debt by issuing more debt, effectively rolling it over.
Refinancing is not a problem, so long as the company in question is able to find buyers to purchase its newly issued debt. But if a large amount of high-yield debt were maturing in the short term, there is a chance that a large number of companies potentially wanting to refinance could outstrip market appetite for so many new issues, leading to liquidity and default problems.
Over the next year the value of bonds maturing sits at 1.5 per cent, and in the subsequent year 7.6 per cent, which is slight when compared with the bonds maturing in more than two years, at 90.9 per cent.
Issuers cashing in
This gives us confidence that the value of bonds that require refinancing in the coming two years is manageable for the market. The maturity wall data suggests that issuers are taking advantage of the low-yield environment to extend the maturity of their existing debt. This has pushed out the peak debt maturity by more than four years, alleviating near-term refinancing risk and suggesting a persistently low default rate in the months, if not years, ahead.
Another factor is the credit breakdown at different maturities. The quality of bonds maturing is predominantly the highest non-investment grade of BB, followed by B-rated debt, with CCC and lower debt making up the smallest amount of the maturing securities. Roughly 70 per cent of this index is of higher-quality BB bonds, and only a small 6 per cent is made up of CCC and lower. This is an ideal maturity schedule as companies with higher ratings generally find it easier to refinance.
High yield can prove an attractive proposition for fixed income investors in rising, low-interest rate environments, because the asset class has a lower duration and higher yield to worst compared with government bonds. The trade-off is, of course, default risk.
Since the European economic cycle is younger in its maturity compared with the US, this could provide a reason to favour the European market at this point.
Nandini Ramakrishnan is a global market strategist at JPMorgan Asset Management
