Issuers of high-yield bonds, who have become complacent in recent years thanks to their ability to borrow at low interest rates, may find themselves up against a “maturity wall” in 2019 and 2020 as bonds come due and interest rates rise.
Maturities for high-yield debt, sometimes referred to as ‘junk’, will ramp up to $104 billion in 2019 from $36 billion in 2018, according to Moody’s Investors Services. That sum will close to double to $182 billion in 2020.
For debt-laden companies who need to roll their bonds over when the principal payments come due, a sharp rise in borrowing costs could catch them ill-prepared.
Martin Fridson, a veteran of the high-yield market, summed up such concerns: “people are mostly focused on 2019, a lot of maturities are coming due then. Regardless of what the economic outlook is, they’re going broke ... It’s a story that gets people riled up.”
The picture could look even worse for high-yield bonds in the event of an economic downturn. Analysts at Guggenheim Partners and Morgan Stanley have suggested a recession in 2019 could be in the cards. In an economy approaching full capacity, the recently passed tax cuts and a potential trillion-dollar infrastructure bill could tip growth over the edge by forcing the Fed into hasty action on interest rates.
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An ensuing recession would prove inconvenient timing for companies who rely on continued access to debt markets to stay afloat. Rolling over the bonds during an economic downturn, when rates for high-yield paper shoot up, could add to the pain of keeping debt on their already stretched balance sheets.
During the 2007-2009 recession, the spread between the benchmark BAML U.S. high-yield index and safer Treasurys TMUBMUSD10Y, +0.00% skyrocketed to a peak of 21.82 percentage points, from a precrisis low of 2.41%. The spread measures the amount of compensation investors demand to buy bonds from dicey borrowers relative to less risky government paper.
High-yield issuers also have to contend with President Donald Trump’s tax bill. The new legislation raised the cap on how much an issuer could deduct in interest payments from their profits. As a result, the more indebted firms, who no longer qualify for the tax loophole, will have less cash to pay back the interest on their bonds.
“Diminished ability of highly leveraged companies to service high interest costs would worsen their refinancing opportunities,” warned analysts at Moody’s Investors Service.
The analysts estimated companies with a debt-to-pretax-earnings ratio, a widely adopted gauge of leverage among market participants, of above 6 are set to see $424 billion of debt mature in the years between 2018 to 2022, more than 40% of bonds from the high-yield sector due over that period.
Despite this downbeat outlook, most market participants are shrugging off such concerns, if only because they’ve seen the ‘maturity wall’ before. To avoid the risk of rolling over their debt when lending conditions are less favorable, companies will repeatedly refinance their debt years ahead of the maturity date.
Most high-yield bonds are callable, in other words, issuers can redeem their debts before they are due.
“They’re always keeping the wolf from that door,” said Fridson. He added when he worked as a strategist at Bank of America Merrill Lynch, the joke among market participants was a high-yield bond would never mature.
“Since most bonds are most callable, it always looks like there’s a maturity wall,” said Gerston Distenfield, director of credit for Alliance Bernstein.
And even if a recession hits during the ‘maturity wall’, the consequences are less dire than imagined. Investors say a recession often needs to last for more than a year before companies feel the pinch.
“It’s a problem only when the market is weak for many years,” said Distenfield.
Jody Lurie, corporate credit analyst at Janney Montgomery Scott, said similar talk of a ‘maturity wall’ in 2014 was circulating within the junk bond market in back around 2012. After investors and credit ratings firms wrote about such concerns ad nauseam, she said, these fears swiftly dissipated when issuers pushed out the wall by refinancing their debt when interest rates were low.
But this time round, the high-yield bond market may find investors unwilling to give issuers a wide berth. The International Monetary Fund reported that high-yield spreads have stayed low even as the ability of U.S. firms to cover their interest expenses have deteriorated in their 2017 Global Financial Stability Report.
“Companies have leveraged up in recent years, so while much of the argument is the same, the dynamics are different (i.e. likely more at the risk of a recession now vs 2014). Companies may not be able to wait to address large debt maturities or may end up in a situation where credit conditions do not allow for ‘kicking the can down the road,’” said Lurie, in e-mailed comments.