Macro

Investors Shun Riskier Junk Bonds as Bankruptcy Filings Hit 346

Investors flee riskier junk bonds as bankruptcy filings hit 346, highest since 2010.

By Barry Stearns

7/11, 00:29 EDT
S&P 500
iShares 20+ Year Treasury Bond ETF
iShares 7-10 Year Treasury Bond ETF
article-main-img

Key Takeaway

  • Investors are shifting from riskier triple-C rated junk bonds to higher-quality double-B debt amid rising bankruptcy filings and high interest rates.
  • The spread for triple-C bonds surged to 9.51 percentage points, while double-B spreads remained stable at 1.9 percentage points.
  • Year-to-date bankruptcy filings hit 346, the highest since 2010, with smaller businesses particularly affected.

Investors Flee Riskier Junk Bonds

Investors are increasingly selling off the riskiest U.S. junk bonds in favor of higher-quality debt, driven by a surge in bankruptcy filings and concerns over how the weakest corners of corporate America will survive a prolonged period of high interest rates. The gap in borrowing costs between companies rated triple-C and lower—the lowest rungs of the $1.3 trillion U.S. junk bond market—and double-B—the highest rung—has surged to almost its widest level since May last year, according to Ice BofA data. This shift highlights growing concerns about weaker companies potentially losing access to funding and defaulting on their debt as borrowing costs remain elevated.

Torsten Slok, chief economist at Apollo, noted, "The sell-off in riskier names is a reflection of worries about the cocktail of higher for longer and the risk of a recession, which would ultimately be very bad news for the most highly levered companies." The premium or "spread" paid by triple-C rated companies to borrow over equivalent Treasury yields rose as high as 9.59 percentage points last week and stood at 9.51 percentage points on Tuesday, up from less than 9.3 percentage points in early June. In contrast, the average spread for double-B junk bonds has remained broadly stable at roughly 1.9 percentage points.

Fed's Rate Policy and Market Impact

The sell-off in the lowest-quality debt adds to concerns about how quickly the U.S. Federal Reserve will cut rates and the extent to which high rates will damage the economy in the meantime. Market expectations have fluctuated this year, with investors currently pricing in about two quarter-percentage-point cuts this year, down from six or seven expected in January. Fed Chair Jay Powell recently stated, "Elevated inflation is not the only risk we face," and warned that leaving borrowing costs too high for too long could "unduly" damage the economy.

Analysts and investors believe higher-grade borrowers typically have more flexibility to handle interest rates at their current 23-year highs, while lower-quality names are more vulnerable. Brian Barnhurst, head of global credit research at PGIM Fixed Income, commented, "Triple-C rated issuers are the least well-equipped to navigate 'higher for longer.' They have higher interest burdens, more constrained cash flows, more constrained liquidity, and perhaps less business flexibility."

Bankruptcy Filings and Economic Concerns

Data from S&P Global Market Intelligence highlighted broader pressures on U.S. companies, with year-to-date bankruptcy filings totaling 346, the highest level for this stage in the year since 2010. Recent bankruptcies include electric-vehicle group Fisker Group Inc and media company Chicken Soup for the Soul Entertainment. Almost all companies that filed for bankruptcy protection in June had less than $1 billion in total liabilities, indicating that smaller businesses are feeling much of the pain.

Bob Schwartz, a portfolio manager at AllianceBernstein, noted, "There are concerns around the U.S. consumer being priced into the high-yield market." Analysts also believe recent concerns over President Joe Biden’s age and chances of re-election are hitting the bonds of weaker corporate borrowers, as investors fear that rates may have to stay elevated as a result. The possibility of a second Trump presidency means investors are anticipating "even more pressure on the government balance sheet, more fiscal stimulus," said PGIM’s Barnhurst.

Street Views

  • Torsten Slok, Apollo (Bearish on the riskiest US junk bonds):

    "The sell-off in riskier names is a reflection of worries about the cocktail of higher for longer and the risk of a recession, which would ultimately be of course very bad news for the most highly levered companies."

  • Brian Barnhurst, PGIM Fixed Income (Bearish on triple-C rated issuers):

    "Triple-C rated issuers are the least well-equipped to navigate ‘higher for longer’. They have higher interest burdens, more constrained cash flows to begin with, more constrained liquidity, perhaps less business flexibility. Higher for longer heightens the risks that they’re going to run into problems."
    "Those things [a second Trump presidency] are presumed by the market to be some degree inflationary, which only adds to the notion of higher for longer."

  • Bob Schwartz, AllianceBernstein (Bearish on lower-grade companies):

    "There are concerns around the US consumer being priced into the high-yield market."