There has been a lot of recent talk about risks within the high yield market, much of them we believe are exaggerated, as we discuss in our piece, “Making Sense of Markets.” One area of concern that has been raised is the state of high yield issuers. For instance, a Bank of America report concluding that the high yield market is laden with highly levered companies that are struggling to grow has recently been making the rounds. This report also discusses how the decline in refinancings as a percentage of total issuance can be a signal that the cycle is turning. We believe that both of these points are a bit misleading and don’t accurately characterize today’s high yield market.
First off on the leverage and growth front, we have been in a very slow growth environment for the extent of this entire “recovery” and high yield default rates have remained subdued the entire time, and are expected to remain we below historical average excluding energy.1
In fact, recent default rates of 1.5% are less than half of historical averages, and rates are expected to remain around this level excluding energy. Additionally, leverage has remained fairly stable (and is actually projected to decline excluding energy as indicated below) and interest coverage (cash flow relative to interest expense) has actually improved.2
So the situation certainly doesn’t seem to be as dire as is being painted; rather in actuality it looks to be improving for the majority of the high yield market.
On the new issue front, we too pay close attention to “use of proceeds.” Generally speaking, the use of proceeds that concerns us most is when bonds are issued to fund mergers and acquisitions/LBOs and dividends. We certainly are not near this level of what we would characterize as “bad behavior” that we saw back in 2006/2007, prior to the 2008 collapse.3