As the coronavirus upends normal life, bond exchange traded funds that track the speculative-grade spectrum are exposed to greater credit risks.
Over the past month, the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) declined 22.0% and the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) decreased 22.8%.
Credit agencies are already issuing a wave of downgrades on corporate bonds as they reevaluate borrowers and their ability to repay obligations amidst the coronavirus pandemic and economic slowdown. For instance, credit-ratings firms like S&P Global Inc. and Moody’s Corp. have already taken away some pristine triple-A ratings or moved other supposedly investment-grade bonds into junk, the Wall Street Journal reports.
Moody’s has warned of a “severe and extensive credit shock across many sectors, regions, and markets.” S&P believed that “the global recession is here and now.” Meanwhile, Fitch Ratings is projecting an “abrupt interruptions happening simultaneously across all major economies” as a result of the coronavirus pandemic.
The weakness comes right after a record borrowing binge in recent years as many companies looked at the relatively low-rate environment as a cheap opportunity to borrow, with more investors willing to chase after speculative-grade debt for their more attractive yields. Regulators and economists have warned that the debt market for high-risk companies may have become overstretched since the financial crisis of 2008.
“What I’ve always worried about is that the existence of overleveraged corporations will exacerbate a downturn that occurs for any reason,” former Fed Chairwoman Janet Yellen told the Wall Street Journal.
The extended low-rate environment has allowed companies to borrow and accumulate a record of $10 trillion in debt. Of that total debt load, $1.2 trillion is in leveraged loans, junk-rated debt secured by corporate assets much like mortgages are backed by homes.
“Investors will probably be surprised by the extent of their losses on loans compared with their historical losses,” Oleg Melentyev, a strategist at Bank of America Corp, warned.
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