The recent wave of defaults and downgrades also strengthened the quality of the high-yield market. At the same time that many of the lowest-rated high-yield bonds defaulted and fell out of indices, many of the lowest-rated investment-grade bonds fell into the high-yield market as fallen angels. Today, the quality of the high-yield market is the highest it’s been in more than a decade.
This is also true of many troubled industries, such as energy, retail and telecom, which got cleaned up in the last downturn and today are both higher quality and a smaller share of the market.
M&A Risk Is Muted
During expansionary periods, companies often take on more debt to fund mergers and acquisitions (M&A) or increase returns to shareholders. When the cycle turns down, they might be left with too much debt or too little liquidity, putting them at risk of ratings downgrades and defaults.
But today, companies’ appetite for borrowing to fund M&A activity is low. In fact, there’s scope for their appetite to grow without impinging on ratings.
To gauge companies’ borrowing appetite, we classify financial policies as conservative, neutral or aggressive. In our analysis, financial policy is currently conservative in half of investment-grade industries and neutral in the other half. This is also mostly true for the high-yield market, except for one industry—technology—which we classify as aggressive.
Collectively, financial policy is likely to become more aggressive over the next 12 months, but our forward credit ratings are stable for more than half of investment-grade issuers, and we expect improvements in credit profiles to outnumber deteriorations in nearly every investment-grade and high-yield industry. That represents the continuation of a recent trend: in the first quarter, ratings upgrades outnumbered downgrades 3.3 to 1.
This doesn’t preclude private-equity funds with large cash balances pursuing leveraged buyouts, but for now the favorable outlook for corporate fundamentals outweighs the risks of re-leveraging via non-strategic buyers. Further, even where we’ve seen private-equity activity, the impact on bond market metrics has been muted.
No Looming Maturity Wall
What’s more, companies have been focused on extending their maturity runways since the start of the pandemic. As a result, there’s no approaching maturity wall, where a large share of bond issues mature and issuers are compelled to procure new debt at prevailing rates. In fact, only 20% of the market will mature by the end of 2025, with the lion’s share of maturities coming between 2026 and 2029.
This is akin to opening a pressure valve as yields rise, because gradual and extended maturities will slow the impact of higher yields on companies (Display). Today, the average coupon in the high-yield market is 5.7%—significantly lower than the current yield to worst. Even if we assume that yields continue to rise and remain high for the next four years, this extended maturity runway means that coupon rates won’t return to pre-COVID levels north of 6% until January 2026.