US high-yield bonds: Breaking the 7% barrier

Yields are moving higher in anticipation of more Fed rate hikes

Markus Allenspach, OpinionIndustry Expert
Markus Allenspach is Head of the Julius Baer Fixed Income Research team and a member of Julius Baers Investment Committee. Markus joined Julius Baer through the acquisition of SBC Wealth Management in 2005, where he had worked in various management positions in Research since 1999. Prior to this engagement, he was Head of Currency & Fixed Income Research at UBS Investment Bank in Zurich. He graduated in Economics at the University of St. Gallen in 1983.

November 20, 2018

"Sounding the Alarm on Leveraged Lending” was the not-so-comforting headline of the International Monetary Fund’s (IMF) blog on Thursday. A leveraged loan is a syndicated loan where the creditor has a leverage ratio (net debt to EBITDA) of 4x and higher, and is typically rated as sub-investment grade.

The message came just as the yield of the Bloomberg Barclays US highyield index surpassed the 7 percent barrier for the first time since July 2016. On a total return basis, the index is down 2.8 percent from its peak on 2 October, and is flat year-to-date.

The S&P leveraged loan total return index, which tracks the leveraged loans the IMF is warning about in its blog, are still up 3.8 percent year-to-date, according to the S&P leveraged loan total return index.

The above-mentioned IMF blog contained no material new information. The Fund merely repeated the observation made in its latest Global Financial Stability Report, namely that the volume of leveraged loans has been growing very rapidly. Bank of America Merrill Lynch estimates that the volume of US leveraged loans has risen by 123 percent since 2010 and now matches the volume of US high-yield bonds, namely $1.1 trillion. The combined volume of riskier debt stands at $2.26 trillion, compared to $1.2 trillion in 2007.

The correction has been orderly and will remain so as long as the Federal Reserve (Fed) raises rates only gradually. Moreover, we see no credit crunch. In fact, the Fed’s survey of Senior Loan Officers shows an easing of credit standards, not a tightening.

Finally, funds are still flowing into senior loan funds, which are invested in floating rate debt mainly. We observe the trends carefully.

Any opinions expressed here are the author’s own.

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