Risky borrowing surges due to the thriving bond market
Weaker enterprises are hastily capitalizing on a buoyant credit market, flooding the market with bonds and loans to refinance existing debt, bolster their balance sheets, and facilitate dividend distributions to their shareholders.
In the month of September, firms including US Foods and Royal Caribbean Cruises secured a total of $109.7 billion through the issuance of junk-rated bonds and loans, as reported by PitchBook LCD data. This marks the third-largest monthly total since records began in 2005.
The additional yield required by investors to hold speculative-grade corporate bonds compared to U.S. Treasurys decreased to 2.85 percentage points last week, slightly above the 14-year lows observed in 2021, as reported by Bloomberg data. It indicates that investors are largely unconcerned about the prospect of an economic slowdown that could trigger bankruptcies and defaults among lower-rated firms.
The primary driver of this optimism is two months of positive labor-market data, which have effectively alleviated summer anxieties regarding a potential recession. The continuous ascent of stock indexes has been complemented by a notable increase in corporate borrowing, reflecting a buoyant sentiment on Wall Street. This trend indicates that even enterprises with higher risk profiles are finding avenues for financing when necessary.
“Credit operates on the principle of confidence, and at this moment, investors are displaying considerable assurance,” remarked Michael Anderson, head of U.S. credit strategy at Citigroup.
Recent borrowing by businesses has yielded significant achievements. In 2022, as the Federal Reserve embarked on a path of aggressive interest rate hikes, concerns emerged regarding the ability of lower-rated firms to secure new financing to service maturing debt obligations.
Currently, only $65 billion of junk-rated bonds and loans within the Morningstar U.S. High-Yield Bond Index and Morningstar LSTA Leveraged Loan Index are set to mature in 2025, as reported by PitchBook LCD. The figure has decreased from $181 billion at the close of the previous year and $347 billion at the conclusion of 2022. The maturity wall has predominantly been deferred to 2028 and subsequent years.
The recent increase in issuance has extended beyond mere refinancings. In September, businesses utilized $22.1 billion in junk-rated loans to distribute dividends to their owners, marking the highest monthly figure since records began in 2000, as reported by PitchBook LCD.
According to investors and analysts, the trend can be attributed in part to elevated interest rates. The challenges have complicated the ability of private-equity firms to divest their portfolio companies, compelling them to seek alternative methods to return capital to their investors.
However, it also serves as a quintessential indicator of an overheated market. Investors exhibit a remarkable eagerness to acquire loans, often opting to increase the debt burden on businesses primarily to benefit equity holders, rather than directing funds towards investments that would enhance the companies’ profitability.
“When capital is plentiful in the market, accompanied by appealing terms, and new debt issuance lags, one inevitably reaches a juncture where more assertive measures begin to emerge,” remarked Randy Parrish, head of public credit at Voya Investment Management.
Belron International, a vehicle-glass repair and replacement firm headquartered in the U.K., has this month completed the largest-ever sale of dividend-funding junk debt, as reported by PitchBook LCD data. The firm secured approximately $9 billion through a loan-and-bond arrangement aimed at refinancing around €4.3 billion, or roughly $4.7 billion, in existing term loans, while also facilitating a shareholder dividend of about €4.4 billion. S&P Global has lowered the company’s credit rating following the transaction, which markedly elevated a key debt-to-earnings ratio.
Nonetheless, the appetite for Belron’s debt, encompassing both dollar and euro elements, proved robust enough that investors consented to diminished yields and less stringent lender protections than originally proposed.
Last week, Chobani executed a notable bond issuance amounting to $650 million, a transaction that permits the yogurt manufacturer to either fulfill interest obligations in cash or postpone payments by generating additional debt. Chobani announced its plans to allocate the proceeds towards a dividend for its indirect parent, with the remainder designated for general corporate purposes. The offering size was expanded from $500 million as demand for the deal surpassed initial expectations.
The current elevated interest rates, compared to those at which numerous companies previously accessed the debt market, have resulted in a gradual increase in the average interest rate on their existing bonds. This trend is expected to persist for the foreseeable future, particularly in light of the Federal Reserve’s recent decision to lower short-term interest rates.
The average coupon of bonds within the Bloomberg U.S. High Yield Index recently stood at 6.34%, an increase from approximately 5.7% in early 2022.
Nonetheless, this figure continues to fall short of the average levels observed throughout much of the 2010s, and certain analysts express a lack of concern regarding the recent gradual uptick.
“They are refinancing debt that was exceptionally inexpensive due to the Fed maintaining rates at zero,” remarked Citigroup’s Anderson. “They are compensating at a higher rate, yet it does not constitute a transformative sum.” It does not constitute a transformative sum for the balance sheet.
