There is a Wave of Risky Borrowing Fueled by the Red-hot Bond Market

Struggling businesses are capitalizing on a booming credit market, issuing a large volume of bonds and loans to refinance older debt, improve their financial stability, and pay dividends to their owners. In September, companies such as US Foods and Royal Caribbean Cruises raised a staggering $109.7 billion in high-yield bonds and loans, marking the third-largest monthly total since records began in 2005, according to PitchBook LCD data.

‍

One of the driving factors behind this surge is the low additional yield that investors demand to hold junk-rated corporate bonds over safer U.S. Treasurys. As of last week, this spread had fallen to just 2.85 percentage points, only slightly above the 14-year lows recorded in 2021. This narrowing gap indicates that investors are not overly concerned about an economic slowdown that could trigger defaults or bankruptcies among lower-rated businesses.

‍

What’s fueling this optimism is two months of encouraging labor market data, which has diminished fears of an impending recession. The strength of the job market has been a key contributor to the upbeat mood on Wall Street, where stock indices have been hitting record highs. The rise in corporate borrowing underscores the confidence that even riskier companies can tap into the credit market when they need it.

‍

"Credit is a confidence game, and right now, investors are showing a lot of confidence," said Michael Anderson, head of U.S. credit strategy at Citigroup.

‍

The surge in borrowing has allowed companies to address concerns that arose last year when the Federal Reserve aggressively hiked interest rates. At the time, there were fears that lower-rated companies might struggle to raise funds to pay off maturing debt. However, this borrowing spree has pushed back the so-called "maturity wall." According to PitchBook LCD, just $65 billion of junk-rated bonds and loans in the Morningstar U.S. High-Yield Bond Index and Morningstar LSTA Leveraged Loan Index are now due to mature in 2025, down from $181 billion at the end of last year and $347 billion at the end of 2022. Much of this debt has been extended to 2028 and beyond, easing immediate repayment pressures.

‍

Beyond refinancing, a significant portion of the funds raised has been directed toward paying dividends to company owners. In September, businesses issued $22.1 billion in junk-rated loans for this purpose, the highest monthly total since records began in 2000. This trend, according to investors and analysts, is partly driven by higher interest rates. Private equity firms, finding it more difficult to sell their portfolio companies, are instead opting to extract cash for their investors through dividends funded by debt.

‍

While this might signal a frothy market, it also reflects investors' eagerness to purchase loans, even if the proceeds are not being used for productive investments that would enhance profitability. Randy Parrish, head of public credit at Voya Investment Management, remarked, “When there’s money available in the market and attractive terms, you eventually reach a point where you see more aggressive actions.”

‍

One of the most notable transactions of this borrowing boom was executed by Belron International, a U.K.-based vehicle-glass repair company. The firm completed the largest dividend-funded junk-debt sale ever, raising around $9 billion in a loan-and-bond deal. The funds were used to refinance approximately €4.3 billion in term loans and distribute a shareholder dividend of €4.4 billion. As a result, S&P Global downgraded Belron’s credit rating due to the substantial increase in its debt-to-earnings ratio. Despite this, demand for the company’s debt was so high that investors accepted lower yields and weaker protections than initially offered.

‍

Chobani, the yogurt company, also made headlines last week by issuing $650 million in bonds. In a rare move, the terms of the bonds allow the company to either pay interest in cash or defer payments by issuing additional debt. Chobani plans to use the proceeds to fund a dividend to its indirect parent company and for general corporate purposes. The deal was so popular that Chobani was able to increase the size of the offering from $500 million to $650 million, thanks to high demand.

‍

As interest rates have risen since many companies last borrowed, the average interest rate on outstanding bonds has been gradually increasing. Even though the Federal Reserve has begun to ease short-term interest rates, the average coupon on bonds in the Bloomberg U.S. High Yield Index recently reached 6.34%, up from around 5.7% in early 2022.

‍

However, this rate is still well below the levels seen throughout much of the 2010s. Citigroup’s Anderson noted that while companies are paying more to refinance debt, the increases are not significant enough to cause major balance sheet concerns. “They are refinancing paper that was ridiculously cheap just because the Fed had rates at zero,” Anderson said. “They are paying more, but it’s not life-changing money. It’s not balance-sheet-changing money.”

‍

In the current credit market, even companies with weaker credit ratings are benefiting from strong investor demand for bonds and loans. This has allowed them to refinance old debt, extend maturities, and pay dividends, all while managing the rising costs of borrowing. Although interest rates have increased, the appetite for riskier corporate debt remains robust, reflecting confidence in the broader economic outlook. However, as companies continue to issue debt for dividends rather than productive investments, some analysts warn that this trend could signal a frothy and potentially risky market environment.

‍