Investors wary of US junk-rated debt risk despite tightening spreads
By Matt Tracy
May 21 (Reuters) -U.S. junk bond investors are resisting a growing temptation to buy the riskiest junk-rated bonds to improve their investment returns as credit spreads - the premium paid over Treasuries by companies - tighten to near record levels.
So far this year, new bond issuance by junk-rated borrowers totaled $137 billion compared to $75.5 billion in the same period last year, according to a JPMorgan report.
Most of this supply been from companies with the highest junk credit ratings to refinance maturing debt - roughly 80% of this year's new bond volume - with investors showing an aversion for the riskiest debt in an uncertain economic environment.
But as they bought the top-rated junk bonds for the relatively higher yields on offer, average spreads on these bonds have tightened sharply, eating into their returns.
Spreads touched 303 basis points on May 6, or just a few basis points away from the tightest levels since the Global Financial Crisis, according to the ICE BofA High Yield Index. They were at 307 basis points on May 20.
But this cheapening of borrowing costs may not be reflective of the true risks building in the asset class, said investors.
Therefore, said Brian Gelfand, co-head of global credit at asset manager TCW, "we do not reach for spread or yield down the ratings spectrum, but rather high-grade our portfolio and wait for better entry points into future volatility."
Market participants anticipate distressed exchanges and defaults will rise as elevated interest rates and persistent inflation eat into the bottom lines of many corporate borrowers, particularly the most heavily indebted and lower-rated issuers.
The dollar volume of defaulted debt rose to more than $33 billion in the first quarter from roughly $19 billion in the fourth quarter of 2023, according to a report by Moody's Ratings.
Distressed exchanges have played a significant role in default activity this year.
There have been $12.8 billion in distressed exchanges so far this year, on pace to beat out the $35.2 billion record-high reached in 2008, the JPMorgan report showed.
"'Time under tension' of higher rates on higher levered issuers has increased the threat of distressed exchanges," said Ginny Schiappa, portfolio manager at investment management firm Income Research + Management.
A Moody's Predictive Analytics report said 134 U.S. public companies defaulted in 2023. If actual defaults occur at the pace predicted by Moody's average probability of default calculations, the number of 2024 defaults would be more than three times the 2023 total.
"Heightened vigilance, active monitoring and management of credit risk in the higher-for-longer rate environment will be critical going forward," it said.
Reporting by Matt Tracy in Washington; Editing by Will Dunham
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