US Junk-Bond Market Is Increasingly Just for Refinancing Itself

Companies are increasingly using the $1.4 trillion US junk-bond market to refinance existing debt, while new borrowing is happening more in private and leveraged loan markets.

(Bloomberg) — Companies are increasingly using the $1.4 trillion US junk-bond market to refinance existing debt, while new borrowing is happening more in private and leveraged loan markets.

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Nearly 80% of junk-bond sales in the US so far this year were for refinancing bonds or loans, the highest percentage since at least 2010, according to data from Barclays Plc. There have been just $59 billion of new high-yield note sales this year through Dec. 4, one of the lowest in more than a decade.  

The appeal of private credit is hard for many companies to resist. Direct lenders have raised vast amounts of money in recent years, with the total assets in the industry topping $1.5 trillion as of late March, giving them ample capital to lend out. They also tend to offer more flexibility to borrowers, and the loans are relatively easy to execute compared with selling bonds, which can be a multistage process where final pricing is only revealed at the end. 

Private credit loans also make fewer demands on bank balance sheets, a positive at a time when capital rules known as Basel III Endgame are set to further constrain some types of risky bank lending. There are regulatory incentives for lending in private markets, and potentially higher returns for investors there too, said Scott Kimball, chief investment officer at Loop Capital Asset Management. 

“High-yield bonds will keep losing market share, until investors grow concerned about illiquidity, transparency and credit quality,” Kimball said.

Money moving from more public credit markets into more private ones mirrors what’s happening in stocks, where the market value of public equity is shrinking while private equity grows. Investors are broadly giving up liquidity in pursuit of potentially higher returns. 

Credit Quality Improves

The US junk-bond market has shrunk about 13% to $1.39 trillion of debt outstanding from $1.59 trillion peak in October 2021, according to Bloomberg index data, based on the face value of the debt. For junk-bond investors, the drop in new sales is a positive. As the amount of debt outstanding shrinks, the value of existing bonds grows. 

Risk premiums, or spreads, have also narrowed this year. The average junk-bond spread could be about two percentage points wider if not for factors including private credit, Edward Altman, a finance professor emeritus at New York University’s Stern School of Business who has spent years studying defaults, said previously. 

Many of the companies opting for private credit are lower rated, and the issuers who remain in the junk-bond market tend to be at the upper end of the high-yield spectrum. That’s resulting in the credit quality improving for the junk-bond market as a whole.    

High-yield default rates have fallen to 1.1%, the lowest level in more than two years, according to a report by JPMorgan Chase & Co. strategists. In contrast, default rates in the syndicated loan market rose to 4% in November, the highest since Covid. 

Ratings-wise, around half of total outstanding junk bonds are in the BB tier, the highest part of the non-investment grade basket. Until the pandemic, when a large number of high-grade companies were suddenly cut to junk, that percentage had averaged closer to 40% going back to 2004. 

“The credit quality of the bond market is better than I’ve ever seen” in 25 years in the high-yield market, said Geof Marshall, head of fixed income and private markets at Toronto-based CI Global Asset Management. 

Rising interest rates often weigh on sales growth for new corporate debt, particularly for companies at the weaker end of the credit spectrum. But even as the Federal Reserve hiked rates in 2022 and 2023, the US leveraged loan and private credit markets both managed to grow, as has the US investment-grade bond market. 

Any company raising funds today is looking at all options, including private debt, according to Dominique Toublan, head of credit strategy at Barclays. 

Private credit is particularly attractive for companies looking to finance leveraged buyouts, CI Global’s Marshall said. The lenders can often promise particular pricing, ready in time for the close of the buyout, which may be more difficult for buyouts depending on funding in public markets. 

Canadian Boom 

While junk-bond sales volume is tepid in the US, the debt is becoming more popular in Canada, growing off a low base. As of Dec. 6, no fewer than eight new issuers — out of 20 total — entered the loonie high-yield market for the first time this year, spurred by relatively cheap funding, and yet unencumbered by a much-smaller private credit presence in the country. 

Companies have raised around C$6.47 billion ($4.57 billion) through high-yield debt sales as of early December, the second fastest pace of issuance since at least 2017, according to data from National Bank of Canada and Bloomberg. 

The pick-up in Canadian corporate new issuance this year has improved the depth and breadth of the Canadian junk-bond market, and that’s one of the reasons asset-management firm Picton Mahoney is switching out US-dollar bonds for Canadian ones, according to Phil Mesman, partner and portfolio manager.

“All else equal, we prefer Canadian dollar to US dollar bonds given growth of the Canadian market, avoidance of excessive currency hedging costs, and a better yield environment and rate outlook,” Mesman told Bloomberg in an interview. The Toronto-based firm has rebalanced its bond book from approximately 75% US to 75% Canadian dollar because of the favorable conditions, he said. 

It will be a while before private credit can rise to the level of competition with the syndicated debt market in Canada, in part because of its banks’ decade-long dominance in credit, Arif Bhalwani, CEO of Third Eye Capital, told Bloomberg in an interview. Private lenders can do business only in niche areas where banks have decided not to play, such as out-of-favor or riskier sectors, Bhalwani said.

In the US, it’s clear that companies have many options for borrowing, even if they have high-yield ratings. 

“You’re seeing increasing convergence between public and private markets, and you’re seeing a lot of issuers actually toggle between broadly syndicated markets and private debt markets,” Bhalwani said.