November 2023 / GLOBAL FIXED INCOME
High Yield Bond Market Changes Provide Support
Transformations have bolstered high yield for a modest downturn.
Key Insights
- The high yield market’s credit quality improvements stemming from recent changes have positioned the asset class well for a moderate economic downturn.
- Credit fundamentals of high yield issuers remain strong as companies have fortified their balance sheets and liquidity profiles to better weather a recession.
- Trends in individual issuance show fewer small, illiquid issues and an increase in secured issues.
In the roughly 15 years since the global financial crisis (GFC), the high yield bond market has improved in several ways. The overall credit quality of the market has improved, the credit profile of individual high yield issuers is stronger, and bonds from larger issuers as well as secured bonds account for an increasing proportion of the market.
Before the GFC, a minority of the high yield bond market held average credit ratings of BB, near the highest end of the high yield rating spectrum. The percentage of the market that is rated BB has steadily increased, and today the majority of the high yield market is rated BB. Encouragingly, 20% of the high yield market was rated within two ratings upgrades of investment-grade status as of June 30, 2023, with 10% of the market within one credit rating upgrade.1
BB Composition of the High Yield Market
(Fig. 1) High yield credit quality has steadily improved
As of August 31, 2023.
Source: Credit Suisse. High yield market is represented by the Credit Suisse High Yield Index. © 2023 CREDIT SUISSE GROUP AG and/or its affiliates. All rights reserved.
This change in market composition occurred over time, with lower-rated issuers migrating to the bank loan market or borrowing in the direct lending market. Those markets have meaningfully increased in size since the GFC. Concurrently, a significant number of issuers migrated from the investment‑grade market to high yield upon credit rating downgrades. The entrance of these “fallen angels” to the high yield market accelerated in 2020 as pandemic-era restrictions negatively impacted many investment‑grade corporates.
High Yield Issuers Transformed
The profile of the average high yield issuer has strengthened. This trend was accelerated by the uptick in fallen angels. Today, the average high yield issuer has a larger balance sheet and generates higher earnings than prior to the GFC. Considering the higher‑quality bias and general financial flexibility afforded larger companies that generate more cash flow, we feel the asset class is in a solid position should the economic outlook weaken.
These transformations in high yield issuers have led to changes in new issues. With larger, higher-quality issuers dominating the high yield market, smaller-sized new issues have fallen dramatically. The larger issue sizes could improve liquidity in the high yield market.
Credit Fundamentals Are Strong, and Balance Sheets Are Fortified
High yield credit fundamentals appear resilient despite a macro backdrop that could be challenging for risk assets. Since the GFC, refinancings have dominated high yield market new issuance as issuers capitalized on historically low interest rates. Following the initial shock from pandemic‑related shutdowns, high yield issuance dramatically increased at attractive financing rates, strengthening issuers’ balance sheet liquidity. Interest coverage metrics also increased, leaving issuers better able to meet their debt service obligations.
In addition, leverage for U.S. high yield issuers has decreased to its lowest level in over a decade. Despite expectations for a slowing economy, earnings have held up for most high yield issuers, especially in industries that had been severely depressed during the pandemic shutdowns, such as cruise operators.
Global High Yield Issues Under USD 250 Million
(Fig. 2) Small issue sizes no longer prominent
As of August 31, 2023.
Sources: J.P. Morgan Chase & Co. North America Credit Research. Based on J.P. Morgan North America Credit Research. Not from an index. Analysis by T. Rowe Price.
Average Leverage Ratio of U.S. High Yield Market Issuers
(Fig. 3) High yield issuers have reduced leverage
As of June 30, 2023.
Sources: J.P. Morgan Chase & Co. North America Credit Research. Based on J.P Morgan North America Credit Research. Not from an index.
Fortified balance sheets and resilient earnings place high yield issuers in a solid position heading into any economic downturn.
More High Yield Issues Offering Enticing Features
To combat rising inflation, the Federal Reserve has raised rates sharply. As a result, many issuers of bank loans, whose coupon payments are tied to short-term rates, have seen their interest costs increase. In order to balance this floating rate exposure, higher-quality bank loan issuers have opted to partially refinance their loans in the high yield bond market, benefiting from the certainty of fixed coupons while offering secured high yield bonds to replace their senior-secured2 floating rate loans. These secured high yield issues place bonds on par with loans at the top of the capital structure, potentially offering creditors higher recovery rates in the event of any default.
Secured high yield bond issuance has recently accelerated, resulting in the highest secured allocation in history. In addition, the amount of junior or subordinate debt in high yield capital structures is at an all-time low, further bolstering recoveries in the event of default.
The High Yield Market Appears Resilient
The current default rate, while a backward-looking metric, is a good indication of the strength of the asset class, in our view. The high yield default rate recently picked up but remains well below its long-term average.
Seniority Structure of Global High Yield Market
(Fig. 4) More high yield bonds appear higher in capital structure
As of August 31, 2023.
Sources: J.P. Morgan Chase & Co. North America Credit Research. Based on J.P Morgan North America Credit Research. Not from an index. Analysis by T. Rowe Price.
Recent defaults have been largely idiosyncratic, including issuers who have defaulted in the past or that recently executed distressed debt exchanges. These defaults appear more company‑specific rather than a result of systemic weakness in the high yield market.
Global High Yield Market Default Rates
(Fig. 5) Defaults are running below the historical average
As of June 30, 2023.
Source: J.P. Morgan Chase & Co. North America Credit Research. Based on J.P Morgan North America Credit Research. Information has been obtained from sources believed to be reliable but J.P. Morgan does not warrant its completeness or accuracy. The index is used with permission. The Index may not be copied, used, or distributed without J.P. Morgan’s prior written approval. Copyright © 2023, J.P. Morgan Chase & Co. All rights reserved.
Changes in the composition of the high yield market have improved the average quality of aggregate market. Amid a relatively low default rate, larger, higher‑quality issuers and new supply offering more attractive characteristics have improved the high yield bond market, in our view.
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Paul Massaro is head of the Global High Yield team and chief investment officer and the portfolio manager of the Floating Rate Bank Loan Strategy in the Fixed Income Division. He is president and chairman of the Investment Advisory Committee for the Floating Rate Fund, president of the Institutional Income Funds, an executive vice president of the Multi-Sector Account Portfolios, and a vice president of the High Yield Fund. Paul also is the chairman of the Investment Advisory Committee of the Institutional Floating Rate Fund and an Investment Advisory Committee member of the High Yield Fund, the High Yield Multi-Sector Account and Floating Rate Multi-Sector Account Portfolios, and the Institutional High Yield Fund. Paul also is a member of the Fixed Income Steering Committee. He is a vice president of T. Rowe Price Group, Inc., T. Rowe Price Associates, Inc., and T. Rowe Price Trust Company.
Rodney Rayburn is a portfolio manager in the Fixed Income Division, managing the Credit Opportunities and High Yield Bond Strategies. He is president of the Credit Opportunities Fund, Inc. He also is executive vice president of the High Yield Fund, Inc., and Institutional Income Funds, Inc., and chairman of their respective Investment Advisory Committees. He is a member of the Investment Advisory Committee for the Balance Fund. Rodney is a vice president of T. Rowe Price Associates, Inc., T. Rowe Price Group, Inc., and T. Rowe Price Trust Company.
Jason Bauer is a sector portfolio manager in the Fixed Income Division. He is responsible for high yield investments. Jason is a vice president and member of the Investment Advisory Committees for the Credit Opportunities, Floating Rate, High Yield, New Income, Total Return, and Value Funds. He also is a vice president of the Institutional Income Funds, Inc., International Funds, Inc., and Multi-Sector Account Portfolios, Inc., and an Investment Advisory Committee member for the Dynamic Credit Fund, Floating Rate Multi-Sector Account Portfolio, Institutional Floating Rate Fund, and Total Return ETF. Jason is a vice president of T. Rowe Price Group, Inc., and T. Rowe Price Associates, Inc.
