The additional premium that investors receive for buying the debt of the lowest-rated companies in the United States has fallen to its lowest level in seven years, resulting in American economy leads to excessive risk-taking.
The premium, or “spread,” above the benchmark US government bond yields with triple C ratings corporate bonds, which are on the verge of bankruptcy, fell to just over 6.4 percentage points, according to data from Ice Data Services. The spread has only been lower on two occasions: in 2014, just before the collapse in oil prices put energy companies into debt, and in the run-up to the 2008 financial crisis.
This is a dramatic recovery from the nearly 20 points offered in the depths of the coronavirus-induced crisis, highlighting the scale of the recovery induced by vaccines and historic fiscal and monetary stimuli.
Investors play an important role in the recovery. They soak up the colossal scale of fundraising that took place during the pandemic, even for companies rated triple C, which gives them more time and stability to survive the crisis.
But optimistic demand means investors are now being compensated for taking high risks, lending money to companies increasingly reliant on debt at declining lending rates, in bets that could easily collapse if the economic recovery disappoints.
“I think there is enough credit complacency right now,” said Nichole Hammond, portfolio manager at Angel Oak Capital. “We don’t think we are paid to invest in the riskiest issuers.”
Many of the worst performing bonds have already defaulted over the past year, dropping Ice’s index and leaving the overall quality of bonds left in better shape.
S&P Global Ratings’ market distress measure, which tracks issuers with bond spreads above 10%, has fallen to its lowest level since October 2007. Bank of America’s credit stress indicator is at its peak. lowest level since 2014.
However, analysts and investors warn that the potential for disaster is masked by accommodating monetary and fiscal policy.
Over the next 12 months, if corporate profits increase by about 25%, analysts at Bank of America still expect debt to earnings before interest, taxes, depreciation and amortization of issuers to triple. C is multiplied by 14, in line with the worst indicators seen in 2009. At the same time, cash flows to high yield funds and the issuance of new debt by lower rated companies begin to decline .
Analysts conclude that the allure of higher spreads in exchange for higher risk in a world of low interest rates is fading as the yields on offer have been dragged down in recent months.
BofA analysts said they believe fund managers are now “struggling” to justify taking risky bets with such low returns. “At some point, the scope of performance hits its limit, and we think it’s here,” they said.