Junk bond market: securities market may replace bank lending, uneasily

The recent banking crisis has advanced the idea that lending and borrowing activities must shift from deposit-taking institutions to the securities market. That transformation may ultimately happen.

Yet for now, the securities market is not a big source of cash for companies. Not a single transaction was priced in the US high yield market last week, according to the research firm LCD. High-yield bond spreads went up a full percentage point in March to more than 5 per cent.

Issuers and investors are struggling to assess both credit risk and the trajectory of base interest rates. For companies hoping for easier conditions this year after a difficult 2022, the sudden seizure of debt markets has again ramped up the likelihood of financial distress and even bankruptcies.

The junk bond market roared early in 2023 amid predictions that the Fed’s tightening cycle would soon conclude. At $35bn, issuance in January and February was the highest since a record 2021. By early March high yield spreads, a measure of market sentiment, had fallen to under 4 per cent, its lowest level in a year. But the downturn in March left the first quarter among the worst for new junk bond sales since the financial crisis.

The balance sheet troubles of regional banks will not necessarily directly affect the prospects of a private equity-backed company trying to sell bonds. But risk appetites are clearly once again inhibited.

In recent weeks, one-time prominent junk bond issuers like WeWork and Carvana have closed or attempted distressed bond exchanges in order to reduce leverage and interest expense. In the previous era of loose money, the pair could probably have raised more cash rather than approach creditors to take haircuts.

WeWork was able to cut a consensual deal. Carvana’s exchange offer, for 71 cents on the dollar, remains outstanding against a canny group of hedge funds. Expect similar fights to unfold in the all-important securities market.