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Junk Loans And High-Yield Bonds: US Grapples With Rising Defaults

Daily Equity - Junk Loans And High-Yield Bonds: US Grapples With Rising Defaults - Financial Times

Leveraged loan defaults in the US reach a 4-year high to 7.2% as of October amid refinancing challenges fueled by high interest rates and weak asset recovery.

Companies in the US are defaulting on leveraged loans at a pace faster than the last four years. This is mainly due to higher interest rates and indebted companies not being able to refinance themselves. 
With the majority of the junk loans coming from the States, defaults soared to its highest since 2020 – 7.2% in the 12 months through October, as per Moody’s reports. When compared with a modest increase in such defaults in the high-yield bond market, data reflects the shift of risky borrowers in corporate America towards the booming loan market during the pandemic.
“We’ve had a decade of uncapped growth in the leveraged loan market,” said Mike Scott, a senior high yield fund manager at Man Group.

From The Pandemic To The New Normal

The leveraged loan market is characteristic to floating interest rates. While the interest rates had hit an extreme low during Covid, companies are now struggling to meet repayment deadlines, burdened by rising rates. Even with the Fed easing its monetary policies, the grapple persists.
As the credit portfolio manager at UBS Asset Management, David Mechlin comments, “There was a lot of issuance in the low interest rate environment and the high rate stress needed time to surface. This could continue into 2025.” With the Fed signalling a contained pace of rate cuts, analysts foresee a continuation of higher default rates in the future.

Distressed Loan Exchanges

A significant portion of leveraged loan defaults involve deals which often result in diminished returns for the investors. They are termed distressed loan exchanges wherein the terms of the deal are renegotiated to extend its maturity period. This enables the borrowing firm to circumvent bankruptcy.
This year, such deals reached a historical high, accounting for more than 50% of defaults, as stated by a lead analyst at S&P Global Ratings, Ruth Yang. “When a debt exchange impairs the lender it really counts as a default,” she said.

Loans or Bonds?

Following the Fed rate cut by 25 basis points, the US long-term bond yield saw a rise last week with the benchmark 10-year treasury yield hitting a six month high. Though there has been a rise in defaults, spreads in the high-yield bond market have remained tight, most since mid-2007, indicating investors’ preference for yields. This is in contrast to the junk loan default rates, which have been hitting record highs recently.
Even then, a few fund managers tend to think of this high to be only short-term, owing to Fed’s continued policy easing.

Market Outlook

The resulting lower borrowing cost from rate cuts would benefit firms that borrowed in the high yield bond or loan market, says Brian Barnhurst, global head of credit research at PGIM.
On the contrary, some analysts blame the weakened quality of documentation for such loans and loosening of credit impositions for the increase in distressed exchanges which primarily leads lenders to suffer.
Lenders will have to manage risks in an uncertain and volatile market now more than ever while concerns continue to linger for borrowers despite some relief with reducing borrowing costs.

Daily Equity

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