Lending Boom of Risky Corporate Debt

Investors’ near-insatiable demand for even the riskiest corporate debt is fueling a Wall Street lending boom, offering lifelines for struggling companies even as the coronavirus pandemic still drags on the economy.

Companies have issued a record $139 billion of bonds and loans with below- investment-grade ratings from the start of the year through last week, according to LCD. More than $13 billion of that debt had ratings triple-C or lower—the riskiest tier save for outright default—about twice the previous record pace.

Despite the onslaught of new bonds, riskier companies can now borrow at interest rates once reserved for the safest type of debt.

The average yield for bonds in the ICE BofA U.S. High Yield Index – a group that includes embattled retailers and fracking companies – was just 3.97%. By comparison, the yield on the 10-year U.S. Treasury note, which carries essentially no default risk, was as high as 3.23% less than three years ago.

“At a high level, you have a meaningful imbalance between supply and demand,” said David Knutson, head of credit research at Schroders. “The demand exceeds the supply for bonds.”

The most striking aspect of the current lending boom is its timing. Typically, it can take years after recessions for the market to reach its present level of exuberance. In this case, it has taken less than 12 months and has arrived just as economic data have revealed a winter slowdown in the recovery.

Debt investors aren’t alone in their enthusiasm. Investors across a range of asset classes have poured money into risky wagers. Their optimism rests on the idea that current economic challenges aren’t normal and can be resolved quickly once coronavirus vaccines are more widely distributed. The combined efforts of the Federal Reserve and Congress have also helped by depressing interest rates and pumping trillions of dollars into the economy.

Strong demand from investors for riskier debt can create a positive feedback loop for companies. Struggling ones can refinance their debt, holding down the overall corporate default rate. That then further boosts investors’ demand. The surge of new money is also rewarding some hedge funds and alternative asset managers who specialize in lending to companies in financial stress.

Some investors and analysts said there are legitimate reasons why the market should be as open as it is now, beyond optimism about the near-term economic outlook.  Still, others aren’t convinced that lower-rated debt is less risky than in the past, arguing that struggling companies will eventually default on their debt when interest rates rise or their own problems worsen.

Source: Wall Street Journal