During the financial crisis, many highly leveraged U.S. corporates faced substantial refinancing risk due to sky-rocketing yields on their debt, as investors fled risky fixed income investments.
Levels of debt manageable during an age of lower interest rates suddenly appeared untenable due to spiking yields demanded by bond markets. Approaching debt maturities raised questions about default, many of which occurred.
Now, a similar though less severe ‘credit crunch’ is starting to emerge again for many highly leveraged companies.
In response to sovereign debt and general financial system concerns, investors have been selling high yield ‘junk bonds’, pushing up their yields. Once again the question arises, ‘How will we roll-over maturing debt at higher than expected interest rates?’
The yield spread on junk bonds has widened 7 basis points this week to 727 basis points after surging to 743 on May 25, the highest level since Dec. 9, Bank of America Merrill Lynch index data show. Spreads have widened 173 basis points since reaching a 30-month low of 554 on April 26. High-yield debt is rated below Baa3 by Moody’s Investors Service and BBB- by Standard & Poor’s.
“The market will hit massive roadblocks when companies have big principal payments coming due and they don’t have the money to repay them,” said Stefan Benedetti, a partner at Dusseldorf-based restructuring specialist Nikolaus & Co LLP. “If the bond market isn’t open, shareholders will have to hand back the keys to the banks.”
Over 17% of junk bonds now have market yields more than 10% above that of similar U.S. Treasuries, which is nearly a doubling from just 9.2% of bonds in a similar situation just last month, according top Bank of America Merrill Lynch. There’s suddenly a lot more distressed debt out there.
This might be opening up investment opportunities here and there for high yield debt, since surely much of this activity is simply across-the-board selling on fear, but watch out. Even if you think markets are wrong for company ‘X’, when it comes time for this company to roll over its maturing debt, the market’s opinion on yield will become very tangible, in the form of the company’s new cost of debt which they’ll be forced to pay even if they can’t afford it, and even if the market is ‘wrong’ in your view.