The riskiest US corporate bonds have faced renewed pressure this year, diverging from the broader debt market rally as concerns persist over stop-start access to funding and worsening distress for low-grade borrowers.
According to data from Ice BofA, Triple C-rated US bonds — the lowest tier of credit quality — now yield an average of 13.6 percent, up from just over 13 percent at the end of 2023, indicative of falling prices.
Correspondingly, the spread, representing the premium that these low-rated borrowers must pay to issue debt over US Treasuries, has widened to 9.28 percentage points from 8.51 percent in late December.
This movement contrasts sharply with the rally seen in higher-quality credit markets in recent weeks, driving a surge in debt issuance. Investment-grade borrowers recorded a record-breaking January for bond sales, while high-yield or “junk” volumes reached a two-year peak as financial leaders capitalized on lower yields to borrow at more favorable rates.
Even with stronger-than-expected US inflation data for January raising concerns about prolonged higher interest rates, overall credit spreads remained relatively stable. For instance, high-grade pharmaceutical company Bristol Myers Squibb successfully sold $13bn of debt on Wednesday.
Investors and analysts attribute the disparity between the spreads of highest- and lowest-quality bonds to persistent concerns about very risky firms losing access to funding, potentially pushing them deeper into distress and triggering more defaults.
Ed Testerman, partner at investment management firm King Street Capital, noted, “Our view is that for reasonably high-quality businesses, there will be interesting ways to access 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 tier of the junk credit spectrum, stood at 2.01 percentage points on February 15, lower than levels seen late last year. This suggests market anticipation of higher default rates and lower recovery rates in the Triple C market, according to Testerman.
However, some observers point out the limited issuance of Triple C-rated debt in recent years, resulting in the low-grade bonds index being highly concentrated around a small group of companies.
Jeremy Burton, US high-yield and leveraged loan manager at PineBridge Investments, commented, “It’s not like triple C is a diversified index. It’s heavily skewed towards stuff that’s been downgraded over time from single B.”
Companies listed with Triple C ratings on Ice BofA’s index include Dish, the TV group that merged with EchoStar, with EchoStar subsequently proposing distressed exchanges. Other Triple C-rated bonds were issued by cybersecurity groups McAfee, Cloud Software Group, and healthcare services company LifePoint Health.
S&P Global Ratings highlighted that Triple C borrowers would face challenges with weak cash flow and elevated interest expenses this year, with defaults expected primarily from consumer-facing sectors and the highly leveraged healthcare sector.
Technology, media, and telecoms companies comprised nearly a third of the entire $174bn Triple C index as of February 15, while healthcare accounted for more than a tenth.
This renewed attention to potential defaults among the riskiest corporate bonds coincides with investors reassessing the outlook for US interest rates, prompted by strong economic data.
Markets are now pricing in three or four quarter-point interest rate cuts from the Fed this year, adding pressure to companies needing to refinance their debt soon.
Jeremy Burton of PineBridge commented, “The market feels really good about overall high-yield credit spread risk right now.” However, investors are “very wary of the bottom 5 or 7 percent of the market, where there is material default risk over the next two years.”
