Defaults by low-rated U.S. companies have fallen to their lowest level in 10 months, helping to extend sharp rallies in the markets for junk bonds and floating-rate loans.
Defaults for an index of speculative-grade loans to U.S. companies over the past year fell to 3.15% as of March, according to S&P Global Market Intelligence’s LCD. That is the lowest level since last April and down from the measure’s 10-year peak in September at 4.17%.
The decline in defaults has helped fuel a strong recovery in the prices of markets that initially were hammered by the Covid-inspired flight from risk. The average yield on a Bloomberg Barclays index of junk bonds as of Thursday was 3.9%, around 0.1 percentage point above the record low of February. Yields fall when bond prices rise.
Loan prices are also rising. The share of loans to North American companies trading at less than 90 cents on the dollar was 4.35% as of April 7, according to Refinitiv—down from 5.18% a month ago and a peak of 75.9% during last year’s selloff.
Lower interest rates and investors’ demand for higher yielding credit assets have helped companies buy time to improve operations, said
Steven Oh,
head of global credit at PineBridge Investments.
“Access to liquidity has been the most crucial piece of the puzzle,” he said. “Markets have more than sufficient liquidity to stave off defaults.”
Default rates for junk bonds and leveraged loans are expected to fall back to pre-pandemic levels over the next year, analysts say. That contrasts with forecasts from last spring, when investors dumped billions of dollars worth of low-rated debt.
Credit investors seeking to benefit from a recovering U.S. economy are moving into higher-yielding assets, analysts say, helping support prices on riskier junk bonds and leveraged loans. Improvements among even the riskiest loan and bond borrowers suggest that prices can continue to rally, investors said.
“You’re going to see more money come into loans and junk bonds because where else are investors going to get yield,” said John McClain, portfolio manager at Diamond Hill Capital Management.
Actions by the Federal Reserve, including cutting interest rates and buying bonds, have helped improve the fortunes of many borrowers. Companies rated double-B or lower raised hundreds of billions of dollars through bond and loan sales last year, followed by record issuance in the first quarter of 2021.
Many investors now expect the distribution of coronavirus vaccines and stimulus money to fuel strong rebounds in GDP growth and corporate earnings. That outlook, combined with many borrowers’ access to capital, is prompting many to say the worst of this cycle is behind.
“Defaults have certainly already peaked,” said Mr. McClain.
Junk-bond prices currently imply a 1.9% default rate over the next 12 months, says Bank of America. For loans, more than 60% of leveraged finance professionals surveyed by LCD in March said they don’t expect defaults to surpass September’s peak in this cycle.
Investors look to these markets as a barometer of credit conditions, since deals tend to involve debt-laden companies with low credit ratings—a combination that tends to deter lending when people get nervous about the future.
At the same time, many portfolio managers warn that any rally has its limits. High debt prices can crimp investors’ returns by reducing opportunities for price appreciation, or by enabling borrowers to issue at lower yields. Valuations are particularly difficult to gauge given the unknowns of exiting a global pandemic, said David Moffitt, co-head of credit management at Investcorp.
“Most businesses are well financed to get to the other side in a normal scenario, but there are more variables now than ever,” he said. “Does that bridge actually connect to anything on the other side?”
Write to Sebastian Pellejero at sebastian.pellejero@wsj.com
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