The bond-market’s math is starting to look a little scary for the riskiest corporate borrowers.
With the Federal Reserve set to raise interest rates for the first time in nearly a decade, a measure of the cost to refinance junk debt has surged to the highest since 2009, according to Bank of America Merrill Lynch data. Investors are demanding more than 18 percent on average to own the debt of companies rated CCC+ or lower, the riskiest in the high-yield category. That compares with 8.3 percent that the companies are currently paying on the debt they’ve been racking up in an era of cheap credit.
For borrowers that have benefited from seven years of cheap money, that’s pointing to one thing: Time may be up. And, increasingly, companies are going to have to ask their creditors to restructure debt to avoid bankruptcy, according to Wells Capital Management.
“The door has closed,” said Margie Patel, a money manager for Wells Capital Management in Boston, which manages $351 billion. “The events of the last week are putting real pressure on the bottom-tier companies, and the ability to finesse your balance sheet through issuing more bonds is pretty much at zero. They won’t be able to extend any longer."
Already reeling from the deleterious effect the lowest oil prices in six years are having on high-yield energy debt, investors are growing more nervous after Third Avenue Management took the rare step of freezing withdrawals from a $788 million credit mutual fund.
Losses of 15 percent in the riskiest part of the market this year are on pace for the worst performance since 2008 and the third worst year on record, according to Bank of America Merrill Lynch Indexes. Yields on the securities -- those rated CCC+ or lower -- have surged to more than 18 percent from a record-low 8.7 percent in June 2014.
The market’s new assessment of junk debt will weigh on companies for years, said Matthew Mish, a credit strategist at UBS Group AG. Appetite for risk globally is souring as the countdown to the Fed’s probable interest-rate increase on Wednesday sparked a selloff in equities and other risk assets.
"The market was lulled into a false sense of complacency by the Fed," said Mish. "The whole idea of a highly levered issuer generating positive cash flow starts to unwind as funding costs go up. A lot of these companies work until they don’t."
Exacerbating the selloff is the fear that there will be fewer buyers willing to step in to stem losses if the selling pressure rises.
That concern may be overblown, according to some investors.
"Fundamentals aren’t that bad," Mike Buchanan, deputy chief investment officer at Western Asset Management, said in a Bloomberg Television interview. "High yield is very attractive right now."
Still, the bad news for creditors may not be over, according to Bank of America Corp. analyst Michael Contopoulos.
Fitch Ratings Service forecast the default rate in the high-yield market will rise to 4.5 percent, up from 3 percent this year. Companies are facing as much as $65 billion of maturing debt that may need to be refinanced over the next two years, according to Fitch Ratings analyst Eric Rosenthal.
Fundamentals have been worsening for the asset class. For every junk-bond issuer that had its rating boosted in 2015, two have been downgraded, a ratio not seen since 2009, according to data compiled by Bloomberg. Oil, trading close to levels last seen during the global financial crisis, remains an overhang on the market.
"There is an underappreciated risk for the default rate to become elevated in 2016 and 2017 that isn’t currently priced into the market," Contopoulos wrote in a report Monday. "Deflationary pressure continues to hurt corporate earnings, U.S. economic growth has been continually revised lower, and yet the Fed is beginning to tighten policy."
Market woes have seen outflows from U.S. high-yield bond funds running at the fastest pace in more than a year as U.S. junk debt has declined 5 percent, poised for its first annual loss since 2008, according to Bank of America Merrill Lynch indexes.
"The reality for lower rated companies now is that they will have more of a challenge in the credit markets," said Christina Padgett, head of North American leveraged finance at Moody’s Investors Service. "We’ve seen the peak of the credit cycle."