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Written by: Len Reininger | Advisor Asset Management
A major theme in corporate credit for the past few years has been growing concern about what could happen to the high yield segment of the corporate sector when billions of dollars of bonds reached maturity dates, also known as the maturity wall. This had the potential to leave these high yield borrowers, or those with the least capacity to repay — through either weak liquidity or limited market access — to be overwhelmed by the growth of these bond maturities. However, and quite unexpectedly, the markets have remained highly receptive to these companies’ debt issues while high yield spreads remain at historic lows. In other words, the markets are not impeding the ability of these high yield companies to issue refinancing bonds which continue to provide liquidity to these weakest companies — high yield bond issuance is near-record levels and high yield spreads are near historic lows. Market liquidity is still there. This has resulted in a very low cost of refinancing of junk-rated bonds (ratings below Baa3/BBB-) with the implied cost of refinancing junk-rated bonds now at its lowest in almost two years, according to the Financial Times.
As a result, these high-rated companies are having success in refinancing their upcoming bond maturities. Consequently, the maturity wall is not quite so steep or high as it was just a year ago. High yield firms have been successfully pushing back their shorter maturities as speculative-grade loan issuance skyrockets.
Source: Wall Street Journal
Speculative-grade issuers are benefiting from a rebound in issuance and tightening credit spreads. Some issuers are also benefitting from easing financing conditions, which are providing them with breathing room to address their near-term maturities.
Source: CreditSights
The resilience of the junk bond market — yield spreads over Treasuries are the narrowest in two years — indicates that the market remains receptive to further refinancing of high yield debt. Meanwhile, the economy has not yet rolled over, attractive yields are bringing lenders back, while cooling inflation keeps rate cuts on the table. It's a potentially favorable set of conditions for junk-rated firms, which tend to begin rolling over their debt earlier than cash-rich investment-grade firms. S&P data shows that non-financial firms globally last year reduced 2024 maturities by 44%, lowered 2025 maturities by 27%, and even started trimming 2026 maturities by 6%. Looking solely at corporate bonds, excluding loans, the 2024 “maturity wall” was reduced by 13% last year and the 2025 wall was lowered by 6%. This has continued in the first two months of this year.
So, does this mean we can all breathe a sigh of relief as the crisis for high yield credit is now behind us? Not quite yet! Recall that all these new refinancings are occurring at a time of higher interest rates. While maturities are being refinanced, the new debt has interest rates that are higher than that of the debt maturing. Although firm leverage has fallen from pandemic highs, rising interest rates have raised firms’ interest expenses. The effects of this monetary policy tightening are likely to continue unfolding over the next few years. As low-yield, fixed-rate corporate debt issued during the pandemic matures, companies, especially high yield ones, are refinancing this debt at higher rates, further increasing their interest expenses and pressuring interest coverage. Higher interest rates will add to issuers' funding costs as they refinance. Based on 4th quarter of 2023 (4Q23) non-financial corporate results, interest rate hikes have lowered interest coverage ratios especially weakening the credit profiles of high yield companies which, by definition, already have weaker liquidity and a more fragile balance sheet than investment grade ones.
It is also noted that while the reduction in near-term maturities should help to ease current pressure on borrowers, the newly issued debt is adding to the maturities due in 2028 — when speculative-grade nonfinancial maturities peak at over $1 trillion. These 2028 maturities were already elevated at the beginning of 2023, and they rose by a further 24% during the year. But this is still a while off.
Another factor to consider is the increasingly questionable state of the U.S. consumer (despite the headline strength of the consumer balance sheet) for which a spending pullback would disproportionately hurt high yield companies. Moody’s believes that while consumer debt balances are generally manageable despite sizable increases, nonresidential consumer debt performance will weaken as borrowing continues to rise, especially in the face of high pricing in consumer-oriented sectors. Over the past two years, banks have tightened credit, particularly for credit card and other consumer loans. Banks also lowered credit limits and raised minimum credit scores for credit card and auto loans, which widened interest rate spreads over the cost of funds. Even eligible borrowers may find their capacity for additional debt limited because of high interest rates. Meanwhile, the Federal Reserve reported that that total consumer credit rose $19.5 billion in January, up from a slight $919 million gain in the prior month. That translates into a gain at a 4.7% annual rate, up from an 0.2% rise in December, and almost double expectations. Revolving credit, like credit cards, accelerated at a 7.7% rate after a 2.4% gain in December. Non-revolving credit, typically auto and student loans, rose 3.6% after a 0.6% drop in the prior month. At the same time credit card delinquencies are rising and auto loans are growing concurrent with a corresponding increasing delinquency rate. New York Fed data show rising delinquency rates on credit cards and autos. Moody’s is forecasting that nonresidential consumer loan delinquencies will continue to increase because of still-tight monetary conditions.
Sources: New York Fed Consumer Credit Panel/Equifax, Survey of Consumer Expenditures and Moody's
Finally, in another sign of growing consumer stress, according to Vanguard, a record-high 3.6% of workers took hardship distributions from their 401k’s in 2023 as inflation and high interest rates are hitting many people's pockets. This cannot be a good sign for the consumer.
In conclusion, while the near-term maturity wall somewhat eases for high-yield companies, this is coming at a cost of higher interest payments at a time when consumer spending levels may be approaching a precarious inflection point. The dangers of high yield stress and defaults are still here.
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