American Airlines, Six Flags, and other companies whose credit ratings have been down-rated to junk keep selling bonds. New issues this year through early August have totaled $91 billion, Bloomberg calculated, 35 percent more than the same period a year ago.

However, as we reported in “The Most Junk Bonds in Three Years Have Been Down-Rated” (1 Aug 2023), the companies are facing stiffer rates and terms to keep borrowing.

Sixty-two percent of the new issues are attached to collateral, giving investors some recourse if a company defaults, the highest proportion of secured junk bonds since 2005, Bloomberg said. 

The bonds also have a shorter shelf life, maturing in an average of 6.1 years instead of the 7.4 years averaged over the previous decade.

Many junk-rated companies refinanced their debt in 2020 and 2021 when interest rates were still near zero, giving them until 2025 to find the cash to repay the principal. Many are waiting to issue new bonds, hoping that interest rates will fall and the overall economy will brighten by then.

Companies selling new bonds now typically have debt maturing soon. They are willing to secure their debt and accept a shorter loan life in return for a more favorable interest rate, Bloomberg said.

The flurry of new bond issues also responds to a shortage of “collateralized loan obligations,” which are securities backed by bonds of varying risk. Speculators are encouraged by the current junk-bond default rate of 3.07 percent, less than the 4.5 percent that prevailed pre-COVID.

However, “default rates are going up,” Randy Parrish, Voya Financial’s chief of public credit, told Bloomberg. 

Companies have been able to keep up debt servicing because inflation has allowed them to sell their products at higher prices, he noted. However, prices now are leveling off while borrowing costs remain high.

“The more companies pledge collateral and issue short, the less flexibility they give themselves later on down the road” if they need to refinance again,  Michael Anderson, Citigroup’s head of U.S. credit strategy, said to Bloomberg.

TREND FORECAST: As interest rates stay high or perhaps rise more, more corporations will slide down the credit-rating scale. At the bottom end, more corporations will default, especially as the Office Building Bust forces banks to tighten lending and private lenders pull back from that sector.

As the bond market tightens, more businesses will lose access to credit. The overall effect will be to hobble the U.S. economy’s growth and push the U.S. closer to a recession.