High Yield Return Scenarios
Elevated starting yields provide cushion for default and maturity wall concerns
Source: ICE BofA US High Yield Constrained Index (HUC0); data 12/31/99 - 10/31/23.
The high yield market has significantly evolved over the past twenty years. Gone are the days of an illiquid market, price inefficiencies and small, highly levered companies dominating the space. Today, 75% of the market has public equity, the median issuer realizes more than $600mm in EBITDA and CCCs account for a much lower percentage of the overall market. While these changes have provided the high yield market with a nice face-lift, all-in returns will likely be modestly lower given less credit and liquidity risk. However, it also provides better downside protection, as defaults are expected to be modest compared to other late cycle periods, limiting credit loss.
HY credit quality
Source: JPMorgan CIB as of 10/31/23
This default rate excludes distressed exchanges, corporate defaults that sit outside of the US high yield market, and is par-, not issuer-, weighted. We believe it is the most accurate default rate when evaluating the high yield market, specifically when trying to quantify credit loss. At the current spread-to-worst, the market is pricing in a default rate of 3.3% and our base case is for the default rate to end 2024 at approximately 3%. Said succinctly, investors are being compensated for default risk at current valuations.
Implied Excess Spread
Source: HUC0 as of 10/31/23. Implied Excess Spread = Spread-to-Worst – ((Default Rate * (1 – Recovery Rate))
Finally, more than $900bn of high yield bonds were issued in 2020 and 2021 at historically low interest rates and were predominantly refinancings. This, in conjunction with elevated interest rates and a dried-up M&A/LBO market, has resulted in very low issuance in 2022 and 2023. This is intuitive, as the average high yield coupon is 6% vs the yield-to-worst of 9.5%; companies that can afford to be patient have been. Less than $200bn of high yield bonds mature in the next two years, and over 85% are BB or single-B rated. The new issue market has been open in 2023, and over 40% of CCCs have addressed their near-term maturities. So, while it is true that the maturity wall is as at an all-time high, we believe this is a weighted average cost of capital exercise and is not a cause for concern as high quality issuers will be able to refinance.
Maturity wall skews higher-quality
Source: J.P. Morgan Asset Management as of 10/31/23.