2024 US High-Yield Outlook: Receding rates, imminent maturities to spur dealmaking

As rates recede and as participants embed soft-landing scenarios into their 2024 outlooks, the focus for the year ahead will shift to the impending maturity wall, leading market participants to project a second straight annual increase in issuance volume from 2022’s threadbare output.

Better funding conditions should allow more issuers to step from the sidelines, where many firmly planted themselves through the Fed’s rate-tightening cycle to sidestep rate volatility and towering absolute costs. A less bellicose Fed, post the Nov. 1 meeting, already is benefiting market tone, even as the primary markets wind down a tumultuous year for the credit markets.

“Right now, the narrative has clearly shifted. In the September-October time frame, it was all about higher for longer,” said Scott Roth, co-head of Barings' US High Yield Investments Group. “That has pivoted to a Goldilocks scenario that has been playing out here.”

“The market has transitioned from ‘Is the Fed done?’ to ‘The Fed is done,’ Roth said. “That has fueled the Goldilocks environment and HY returns in November were north of 4%. We came into 2023 and market economists were anticipating a recession that never materialized but now we’re looking at a soft landing as the most likely outcome.”

Supply: On the up and up
Opinions vary on what to expect from issuance next year, but most desks are banking on an upswing.

To recap, 2023’s volume totaled $175 billion (through Dec. 12), easily thrashing the anemic $102 billion printed in 2022, but falling short of the record-setting $465 billion in 2021 and robust $435 billion in 2020.

Among the bulls, Barclays is eyeing $200-230 billion of high-yield volume and JP Morgan has penciled in $225 billion of gross new issuance. More bearish, BofA Global Research and Deutsche Bank project gross issuance in 2024 at $165 billion and $175 billion, respectively.

“Primary markets can surprise to the upside if disinflation accelerates without a significant shock to growth and the Fed is able to ease policy,” says Deutsche Bank.

For loan volume, estimates span from $240-375 billion, also indicating expectations for a second straight annual increase.

Feeling secured
As rates swelled through October, institutional loan volume totaled $233 billion through Dec. 13, up a modest 4% year-over-year, and eclipsed by the $615 billion amount in 2021. Many issuers rebalanced their funding mixes away from loans and into fixed-rate bonds, as loan costs trended north of those for bonds. Secured bond volume more than tripled year-over-year, to $105 billion, or 60% of overall issuance volume. Issuance of unsecured bonds dipped to a second straight post-GFC low, at $68 billion.

Additionally, bond-for-loan take-out activity, including repayment of institutional and pro rata facilities, has surged year-to-date to nearly $54 billion, from $10 billion in 2022. Indeed, 28% of this year’s high-yield bond volume was issued with the sole purpose of refinancing bank loans, the highest share since 2010, up from just 10% in 2022 and 18% average in the last ten years.

Average borrowing costs neared post-GFC heights in 2023, touching 8.75% in 2023, widening 140 bps year-over-year. For secured bonds, new-issue yield finalized at 9.04%, and at 8.47% for unsecured prints. These elevated costs prompted borrowers to increasingly huddle into short-dated paper. Of the 250 tranches inked in 2023, 132 sported a final maturity of six years or less. Eight-year maturities — historically the tenor of choice for high-yield issuers — stumbled to an atypically low count of 46 tranches. Deals dated longer than eight years accounted for just six tranches this year, an all-time low.

Use of proceeds: Running on refis
While estimates for full-year issuance are a mixed bag, strategists agree that trends on the primary market next year will be directed by refinancing needs. Already in 2023, refi-driven bond placements accounted for 62% of completed supply, up from 48% in 2021.

“The record maturity wall will force a wave of supply in the form of refinancings, which we expect to be about two-thirds of total supply,” says the team at Barclays, noting $130 billion of par due to mature over the next two years.

Mitigating the forward risks, many issuers successfully addressed their debt loads during the ultra-low rate Covid era, said Jordan Lopez, director and head of high yield strategy at Payden & Rygel during a media briefing.

“Most companies did a very good job during second half of 2020 and pretty much all of 2021 of extending maturities, refinancing higher coupons into lower coupons. So, we see a lot of flexibility as far as that goes.”

But, the situation may become more dire for those who choose to sit tight.

“I think what tends to happen is companies tend to overplay their hands,” says Barings Roth. “They tend to be optimistic about the future and don’t appreciate that access to the capital markets can be tenuous. If there is a window to access, you should access. If you’re a lower credit, maybe you don’t have other levers to pull to address the maturity.”

Street estimates also largely signal another lackluster year for M&A and leveraged buyout (LBO) bond supply. The team at Barclays says “M&A and LBO issuance should remain very light, as the math on such deals is less compelling given current financing costs.”

Deutsche Bank agrees. “We are not expecting too many LBOs,” the bank said. “A lack of LBOs means that much of the leveraged finance deals in the USD market are likely to be refinancing deals and secured high-yield bonds rather than loans.”

Tracking at slightly more than 7% in 2023, the share for LBO-backing deals plunged from 15% in 2022, according to LCD. M&A bond prints, excluding LBOs, were a roughly 15% share, a three-year low for the purpose.

Perhaps an outlier, JP Morgan says it is “optimistic for a modest rise in M&A related activity” in the year ahead.

Spreads: The party’s over?
High-yield bond spreads proved to be resilient as the broader financial markets grappled with whipsawing Treasury rates, hovering at T+359 in mid-December, per the S&P US High Yield Corporate Bond Index (SPUHYBD).  The tide may turn in 2024, however, with most Street projections for the metric finalizing in the 450-475 bps range by year-end. There could be additional hiccups along the way, as Deutsche Bank noted, “In Q2 we are expecting growth data to deteriorate more quickly and for spreads to follow suit” with high-yield bond spreads peaking at 745 bps during that time frame.

Returns: Muted-to-flat
Performance for the asset class was stellar at the year’s opening, as high-yield posted a breathtaking 3.82% gain in January, according to the SPUHYBD. But hawkish rhetoric from the Fed and the March banking crisis led to uneven performance through October, punctuated by November’s strong 4.64% gain on the Fed’s apparent détente, and further strong gains post the December FOMC event. This boosted the total return for the full-year to 10.5% through mid-December, marking a stark turnaround from a roughly 11% annual loss in 2022.

Total return estimates in 2024 are dispersed, ranging from a modest 4.5% to an impressive 11%. For the team at Barclays, which is eyeballing a return of 4.5-5.5%, this assumption is predicated on “expectations that two-year and five-year Treasury yields will rally to 4.2% and 4.3% at YE24.”

JP Morgan represents the high-end of the returns forecast. It expects high-yield bond spreads to widen 50 bps by year-end 2024, though that would be against a larger decline in 5-year Treasury yields, which would trim 50 bps from the high-yield YTW, to 8.35%.

Ratings: Up-in-quality trade persists
Headed into 2023, investors were advised to shift portfolio weightings to the higher rungs of the ratings ladder, a theme likely to extend into coming year.

“We recommend investors overweight BBs, neutral single Bs, and underweight CCCs. Given an extended distressed/default cycle and lower forecasted growth and rates, we believe investors should position up-in-quality in 2024," says JP Morgan.

Indeed, CCC bonds withered to less than 1% of overall issuance in 2023. The prior annual low was 3.7% in crisis-scarred 2009, according to LCD. BB bonds finalized with a 30% allotment, and B bonds at 37%, an 11-year high.

“We have the lowest exposure to CCC ratings category we’ve had in years,” says Barings’ Roth. “Historically, we tend to be overweight the single B and triple C rating categories. We’re not afraid to go into CCC credits given the strength of our research platform but we’ve reduced exposure in 2023. Conversely, we’ve added a lot of BBB exposure given the spread between BBBs and BBs.”

Defaults: Grinding higher
Per most Street outlooks, default rates in 2024 will increase, with expectations for the year to finalize in the 2.75%-5.9% range. “We expect defaults to continue to accelerate going into 2024 … nine out of ten defaults should come from healthcare, retail, cable, and telecom/media/tech sectors,” says BofA Global Research. “Looking across all forms of corporate credit globally, we expect $180bn in default volume, or a 5.2% default rate.”

For reference, S&P Global Ratings Credit Research & Insights expects the US trailing-12-month speculative-grade corporate default rate to reach 5% by September 2024, from 4.1% in September 2023, as companies grapple with higher interest and as slower growth ahead strains cash strapped balance sheets.

Nick Burns, senior vice president and high yield portfolio manager with Payden & Rygel, doesn’t foresee a substantial uptick in defaults.

“Obviously it's hard to make a call on exogenous shocks, but the baseline expectation for 2024 we think has to be that a material spike in default rate is very unlikely,” said Burns. "And actually, when you look at the distress levels in the market today about 10 issuers constitute about 80% of the distressed capital structures. What we think is going into '24, we're going to continue to have a baseline level of defaults gradually increasing.”

Featured image by EschCollection/Getty Images

This article originally appeared on PitchBook News