The U.S. high-yield debt market, also known as junk bonds, has grown to a record size, the Financial Times reported, as a record 149 companies this year, such as Coinbase and Medline, have locked into rock-bottom interest rates and investors seeking to boost yields tapped cheap money to take a flyer on higher-risk companies.
We alerted readers to this trend early in “Risky Companies Snapping Up Cheap Loans” (23 Feb 2021) and in other Trends Journal articles.
Twenty-six new bond issues washed into the junk bond market in September, tying last April’s record for the most in a single month; another 13 companies issued high-yield bonds from 1 through 25 October, according to the FT.
The swelling junk bond market is part of the rapidly growing private credit sector that is attracting fresh attention from pension funds, wealthy individuals, and others hoping to raise their rates of return (see related article in this issue).
Low interest rates are drawing corporations looking to borrow cheaply and drawing investors willing to take on risk if it might bring a higher return.
“A lot of those deals are made possible by the very low cost of capital and, with that, you see more [borrowers] coming into the high-yield bond market,” Chris Blum, BNP Paribas’ chief of leveraged finance, told the FT.
The growing level of leveraged corporate debt, driven by investors seeking higher yields, could “exacerbate existing vulnerabilities” in the global financial system, the International Monetary Fund recently warned.
The average credit rating of companies issuing junk bonds has fallen since the COVID War began, Standard & Poor’s reported in September.
However, high-yield bonds are not living up to their name: investors are being paid relatively little for taking a greater risk, the FT noted, a trend we first highlighted in “Junk Bond Yields Fall to Record Lows,” 16 Feb 2021.
The average yield in junk bonds is 4.2 percent, perilously close to the historic 3.78-percent low reached earlier this year, according to Ice Data Services. The yield in Europe is averaging a dismal 2.74 percent, the FT reported.
“Growth in [the number of] new issuers at the lowest levels has historically been associated with higher default rates and economic downturns,” the S&P report pointed out.
TRENDPOST: We warned of the junk-bond market’s dangers in “Corporate Bond Market Bubble” in our 5 January, 2021 issue.
As we noted then, the U.S. Federal Reserve’s decision to buy junk bonds to keep risky companies in business helped keep the economy from crashing and courts being swamped by bankruptcy applications.
However, the Fed’s generosity also sparked the greatest corporate borrowing spree on record, which followed years of already-low interest rates that encouraged businesses to borrow their way out of the aftermath of the Great Recession.
The New York Times wrote at the time, “the concern is that [the Fed] has simply left businesses comatose on central-bank life support.”
TREND FORECAST: When the Fed begins cutting its bond purchases, interest rates on risky loans will rise, jeopardizing overleveraged companies’ ability to keep up repayments.
We foresee a panic at that point as investors run from junk bonds. As a result, companies that have been kiting loans to stay alive will crash and burn, taking jobs and capital with them and slowing economic growth globally and in the U.S. in particular.