Editing High-yield debt

{{Short description|Financial product}}
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{{Financial markets}}

In finance, a '''high-yield bond''' ('''non-investment-grade bond''', '''speculative-grade bond''', or '''junk bond''') is a [[Bond (finance)|bond]] that is rated below [[investment grade]] by [[credit rating agencies]]. These bonds have a higher risk of [[default (finance)|default]] or other adverse [[credit event]]s but offer higher [[Yield (finance)|yield]]s than investment-grade bonds to compensate for the increased risk. As of 2024, high-yield [[Bond (finance)|bonds]] have a higher yield than [[U.S. treasuries|U.S. Treasury securities]].

==Default risk==
As indicated by their lower [[credit rating]]s, high-yield debt entails more risk to the investor compared to [[investment grade]] bonds. Investors require a greater [[Yield (finance)|yield]] to compensate them for investing in the riskier securities.<ref>{{cite book |last= Fabozzi|first= Frank J. |title=The Handbook of Fixed Income Securities |date=1997 |publisher=[[McGraw Hill]] |location=New York |isbn=0-7863-1095-2 |pages=220–221 |edition=fifth}}</ref>

In the case of high-yield bonds, the risk is largely that of default: the possibility that the issuer will be unable to make scheduled interest and principal payments in a timely manner.<ref name="thau2000">{{cite book |last=Thau |first=Annette |title=The Bond Book |date=2 November 2000 |publisher=McGraw-Hill |location=New York |isbn=0-07-135862-5}}</ref><sup>:208</sup> The default rate in the high-yield sector of the U.S. bond market has averaged about 5% over the long term. During the liquidity crisis of 1989–90, the default rate was in the 5.6% to 7% range. During the [[COVID-19 pandemic]], default rates rose to just under 9%.<ref name="economist">{{cite news |title=America's high-yield debt is on ever-shakier foundations |url=https://www.economist.com/finance-and-economics/2021/06/17/americas-high-yield-debt-is-on-ever-shakier-foundations |newspaper=The Economist |access-date=1 July 2021}}</ref><ref name="thau2000" /><sup>:209</sup> A [[recession]] and accompanying weakening of business conditions tends to increase the possibility of default in the high-yield bond sector.{{Citation needed|reason=statement\paragraph should be supported by citation to a reliable source. See [[Wikipedia:Reliable sources]]| date=July 2021}}

==Investors== 
Institutional investors (such as [[pension fund]]s, [[mutual funds]], banks, and [[insurance companies]]) are the largest purchasers of high-yield debt. Individual investors participate in the high-yield sector mainly through mutual funds.<ref name="thau2000" /><sup>:211</sup>

Some institutional investors  have [[by-law]]s that prohibit investing in bonds which have ratings below a particular level. As a result, the lower-rated securities may have a different institutional investor base than investment-grade bonds.{{Citation needed|reason=statement\paragraph should be supported by citation to a reliable source. See https://en.wikipedia.org/wiki/Wikipedia:Reliable_sources| date=July 2021}}

==U.S. market and indices==
U.S. high-yield bonds outstanding as of the first quarter of 2022 are estimated to be about $1.8 trillion, comprising about 16% of the U.S. corporate bond market, which totals $10.7 trillion. New issuances amounted to $435 billion (~${{Format price|{{Inflation|index=US-GDP|value=435000000000|start_year=2020}}}} in {{Inflation/year|US-GDP}}) in 2020.<ref name="economist"/><ref>{{cite web |title=Statistics |url=https://www.sifma.org/resources/archive/research/statistics/ |website=SIFMA Research |access-date=2 July 2021}}</ref>

Indices for the high-yield market include:
* ICE Bank of America US High Yield Total Return Index,<ref>{{cite web |title=ICE BofA US High Yield Total Return Index |date=31 August 1986 |url=https://fred.stlouisfed.org/series/BAMLHYH0A0HYM2TRIV |publisher=Federal Reserve Bank of St. Louis}}</ref>
* Bloomberg Barclays US Corporate High Yield Total Return Index,<ref>{{cite web |title=Bloomberg Barclays US Corporate High Yield Total Return Index |url=https://www.bloomberg.com/quote/LF98TRUU:IND |website=Bloomberg |access-date=3 July 2021}}</ref> 
* S&P U.S. Issued High Yield Corporate Bond Index,<ref>{{cite web |title=S&P U.S. High Yield Corporate Bond Index |url=https://www.spglobal.com/spdji/en/indices/fixed-income/sp-us-high-yield-corporate-bond-index/#overview |website=Standard and Poors |access-date=3 July 2021}},</ref> and 
* FTSE US High-Yield Market Index.<ref>{{cite web |title=FTSE US High-Yield Market Index |url=https://www.yieldbook.com/m/indices/single.shtml?ticker=USHYMI |website=Yield Book |publisher=FTSE Russell |access-date=3 July 2021}}</ref>

Some investors, preferring to dedicate themselves to higher-rated and less-risky investments, use an index that only includes BB-rated and B-rated securities. Other investors focus on the lowest quality debt rated CCC or [[distressed securities]], commonly defined as those yielding 1,000 [[basis point]]s over equivalent government bonds.<ref>{{Cite news |date=30 August 2012 |title=S&P: U.S. distress ratio declines below its 1-yr average |url=https://www.reuters.com/article/markets/us/sp-us-distress-ratio-declines-below-its-1-yr-average-idUSWNA4392/ |access-date=16 August 2024 |work=Reuters}}</ref>

==Usage==
=== Corporate debt ===
The original speculative grade bonds were bonds that once had been investment grade at time of issue, but where the credit rating of the issuer had slipped and the possibility of default increased significantly. These bonds are called "fallen angels".

The [[investment banker]] [[Michael Milken]] realized that fallen angels had regularly been valued less than what they were worth. His experience with speculative grade bonds started with his investment in these. In the mid-1980s, Milken and other investment bankers at [[Drexel Burnham Lambert]] created a new type of high-yield debt: bonds that were speculative grade from the start, and were used as a financing tool in [[leveraged buyout]]s (LBOs) and [[hostile takeover]]s.<ref name="thau2000" /><sup>:208</sup> In a LBO, an acquirer would issue speculative grade bonds to help pay for an acquisition and then use the target's [[cash flow]] to help pay the debt over time. Companies acquired in this manner were commonly saddled with very high debt loads, hampering their financial flexibility. Debt-to-equity ratios of at least 6 to 1 were common in such transactions. This led to controversy as to the economic and social consequences of transforming firms through the aggressive use of financial leverage.<ref>{{cite book |last1=Ross, Stephen A; Westerfield, Randolph W.; Jordan, Bradford D |title=Fundamentals of Corporate Finance |date=2010 |publisher=McGraw-Hill/Irwin |location=Boston |isbn=978-0-07-724612-9 |page=211 |edition=Ninth}}</ref>

In 2005, over 80% of the principal amount of high-yield debt issued by U.S. companies went toward corporate purposes rather than acquisitions or buyouts.<ref>{{cite news| url = http://www.jpost.com/Business/Commentary/Need-more-retirement-income-Look-at-high-yield-bonds |title= Need more retirement income? Look at high yield bonds |author=Aaron Katsman|newspaper=[[The Jerusalem Post]] |date = 6 June 2012}}</ref>

In emerging markets, such as China and Vietnam, bonds have become increasingly important as short term financing options, since access to traditional bank credits has always been proved to be limited, especially if borrowers are non-state corporates. The corporate bond market has been developing in line with the general trend of capital market, and equity market in particular.<ref>{{cite web |url=http://www.vietnamica.net/op/wp-content/uploads/2010/11/VuongTran.JEPR_.Vol6_.No1_.2011.pdf |title=Vietnam's corporate bond market, 1990–2010: Some reflections |publisher=The Journal of Economic Policy and Research, 6(1): 1–47 |date=15 March 2011 |access-date=27 November 2010 |archive-date=26 September 2020 |archive-url=https://web.archive.org/web/20200926105418/http://www.vietnamica.net/op/wp-content/uploads/2010/11/VuongTran.JEPR_.Vol6_.No1_.2011.pdf |url-status=usurped }}</ref>

=== Debt repackaging and subprime crisis ===
High-yield bonds can also be repackaged into [[collateralized debt obligation]]s (CDO), thereby raising the [[credit rating]] of the senior [[tranche]]s above the rating of the original debt. The senior tranches of high-yield CDOs can thus meet the minimum credit rating requirements of pension funds and other institutional investors despite the significant risk in the original high-yield debt.
[[Image:Lehman Brothers Times Square by David Shankbone.jpg|thumb|The New York City headquarters of Barclays (formerly Lehman Brothers, as shown in the picture). In background, the [[AXA Center]], headquarters of [[AXA]], first worldwide insurance company.]]
When such CDOs are backed by assets of dubious value, such as [[subprime mortgage]] loans, and lose [[market liquidity]], the bonds and their derivatives become what is referred to as "toxic debt". Holding such "toxic" assets led to the demise of several [[investment bank]]s such as [[Lehman Brothers]] and other financial institutions during the [[subprime mortgage crisis]] of 2007–09 and led the US Treasury to seek congressional appropriations to buy those assets in September 2008 to prevent a systemic crisis of the banks.<ref>{{cite news| url = https://www.telegraph.co.uk/finance/financialcrisis/6173145/The-collapse-of-Lehman-Brothers.html| archive-url = https://web.archive.org/web/20110309203357/http://www.telegraph.co.uk/finance/financialcrisis/6173145/The-collapse-of-Lehman-Brothers.html| url-status = dead| archive-date = 9 March 2011|title= The collapse of Lehman Brothers|newspaper=[[The Daily Telegraph]]|access-date= 1 August 2014}}</ref>

Such assets represent a serious problem for purchasers because of their complexity. Having been repackaged perhaps several times, it is difficult and time-consuming for [[auditor]]s and accountants to determine their true value. As the [[recession]] of 2008–09 hit, their value decreased further as more debtors defaulted, so they represented a rapidly [[depreciating asset]]. Even those assets that might have gone up in value in the long-term depreciated rapidly, quickly becoming "toxic" for the banks that held them.<ref>{{cite web|url=http://marketplace.publicradio.org/videos/whiteboard/toxic_assets.shtml |archive-url=https://archive.today/20120711085336/http://marketplace.publicradio.org/videos/whiteboard/toxic_assets.shtml |url-status=dead |archive-date=11 July 2012 |title=Marketplace Whiteboard: Toxic assets |publisher=[[Marketplace]] |access-date=20 March 2009 }}</ref> [[Toxic asset]]s, by increasing the variance of banks' assets, can turn otherwise healthy institutions into [[Zombie bank|zombies]]. Potentially insolvent banks made too few good loans creating a [[debt overhang]] problem.<ref>{{Cite journal |last=Wilson |first=Linus |date=2 February 2009 |title=Debt Overhang and Bank Bailouts |journal= |publisher=SSRN |doi=10.2139/ssrn.1336288 |s2cid=153681120 |ssrn=1336288}}</ref> Alternatively, potentially insolvent banks with toxic assets sought out very risky speculative loans to shift risk onto their depositors and other creditors.<ref>{{cite journal |last1=Wilson |first1=Linus |last2=Wu |first2=Yan Wendy |title=Common (stock) sense about risk-shifting and bank bailouts |journal=Financial Markets and Portfolio Management |date=2010 |volume=24 |issue=1 |pages=3–29 |doi=10.1007/s11408-009-0125-y|ssrn=1321666 |s2cid=153441066 }}</ref>

On 23 March 2009, U.S. Treasury Secretary [[Timothy Geithner]] announced a [[Public–private partnership|Public-Private Investment Partnership]] (PPIP) to buy toxic assets from banks' balance sheets. The major stock market indices in the United States rallied on the day of the announcement rising by over six percent with the shares of bank stocks leading the way.<ref name='Edmund L. Andrews and Eric Dash'>
{{cite news | title= U.S. Expands Plan to Buy Banks' Troubled Assets | date= 24 March 2009 | newspaper= New York Times | url = https://www.nytimes.com/2009/03/24/business/economy/24bailout.html | access-date = 12 February 2009 | first1=Edmund L. | last1=Andrews | first2=Eric | last2=Dash}}</ref> PPIP has two primary programs. The Legacy Loans Program will attempt to buy residential loans from banks' balance sheets. The [[Federal Deposit Insurance Corporation]] will provide non-recourse loan guarantees for up to 85 percent of the purchase price of legacy loans. Private sector asset managers and the U.S. Treasury will provide the remaining assets. The second program is called the legacy securities program which will buy mortgage backed securities (RMBS) that were originally rated AAA and commercial mortgage-backed securities (CMBS) and asset-backed securities (ABS) which are rated AAA. The funds will come in many instances in equal parts from the U.S. Treasury's [[Troubled Asset Relief Program]] monies, private investors, and from loans from the Federal Reserve's [[Term Asset-Backed Securities Loan Facility|Term Asset Lending Facility]] (TALF). The initial size of the Public Private Investment Partnership is projected to be $500 billion.<ref>{{cite web |url=http://www.treas.gov/press/releases/reports/ppip_fact_sheet.pdf |title=FACT SHEET PUBLIC-PRIVATE INVESTMENT PROGRAM |publisher=U.S. Treasury |date=23 March 2009 |access-date=26 March 2009 |archive-url=https://web.archive.org/web/20090324012024/http://www.treas.gov/press/releases/reports/ppip_fact_sheet.pdf |archive-date=24 March 2009 |url-status=dead }}</ref> Nobel Prize–winning economist [[Paul Krugman]] has been very critical of this program arguing the non-recourse loans lead to a hidden subsidy that will be split by asset managers, banks' shareholders and creditors.<ref>{{cite news|author=Paul Krugman|url=https://krugman.blogs.nytimes.com/2009/03/23/geithner-plan-arithmetic/ |title=Geithner plan arithmetic|newspaper=New York Times |date=23 March 2009 |access-date=27 March 2009}}</ref> Banking analyst [[Meredith Whitney]] argues that banks will not sell bad assets at fair market values because they are reluctant to take asset write downs.<ref name='John Carney'>
{{cite news | title= Meredith Whitney: A Bad Bank Won't Save Banks | date= 29 January 2009 | publisher= businessinsider.com | url = http://www.businessinsider.com/2009/1/meredith-whitney-a-bad-bank-wont-save-us | access-date = 27 March 2009 }}</ref> Removing toxic assets would also reduce the volatility of banks' stock prices. Because stock is akin to a [[call option]] on a firm's assets, this lost [[Volatility (finance)|volatility]] will hurt the stock price of distressed banks. Therefore, such banks will only sell toxic assets at above market prices.<ref>{{cite journal |last1=Wilson |first1=Linus |title=The put problem with buying toxic assets |journal=Applied Financial Economics |date=January 2010 |volume=20 |issue=1–2 |pages=31–35 |doi=10.1080/09603100903262954|ssrn=1343625|s2cid=218640283 }}</ref>

==EU member state debt crisis==
{{See also|European sovereign debt crisis}}

On 27 April 2010, the [[Economy of Greece#2010 debt crisis|Greek debt]] rating was decreased to "junk" status by [[Standard & Poor's]] amidst fears of default by the [[Greek Government]].<ref name=nyt04282010>{{cite news |url=https://www.nytimes.com/2010/04/28/business/global/28drachma.html |first1=Jack |last1=Ewing |first2=Jack |last2=Healy|title=Greek Debt Rating cut to Junk Status |work=[[The New York Times]] |date=27 April 2010 |access-date= 15 October 2020}}</ref> They also cut [[Portugal]]'s [[credit rating]]s by two notches to A, over concerns about its [[state debt]] and [[public finance]]s on 28 April.<ref>{{cite news| url=http://news.bbc.co.uk/1/hi/business/8648029.stm | work=BBC News | title=Fears grow over Greece shockwaves | date=28 April 2010 | access-date=4 May 2010}}</ref>
On 5 July 2011, Portugal's rating was decreased to "junk" status by [[Moody's]] (by four notches from Baa1 to Ba2) saying there was a growing risk the country would need a second bail-out before it was ready to borrow money from financial markets again, and private lenders might have to contribute.<ref>{{cite news|
url=https://www.bbc.co.uk/news/business-14038529 | work=BBC News | title=Portugal's debt is downgraded to junk status by Moody's | date=5 July 2011 | access-date=5 July 2011}}</ref>

On 13 July 2012, Moody's cut Italy's credit rating two notches, to Baa2 (leaving it just above junk). Moody's warned the country it could be cut further.

With the ongoing [[deleveraging]] process within the European banking system, many European CFOs are still issuing high-yield bonds. As a result, by the end of September 2012, the total amount of annual primary bond issuances stood at {{€|50 billion|link=yes}}. It is assumed that high-yield bonds are still attractive for companies with a stable funding base, although the ratings have declined continuously for most of those bonds.<ref>{{cite news |url=http://www.cfo-insight.com/financing-liquidity/loans-and-bonds/fitch-high-yields-to-remain-good-alternative-in-europe/ |archive-url=https://web.archive.org/web/20130111032216/http://www.cfo-insight.com/financing-liquidity/loans-and-bonds/fitch-high-yields-to-remain-good-alternative-in-europe/ |url-status=dead |archive-date=11 January 2013 |title=Fitch: High-Yields to Remain Good Alternative in Europe |work=CFO Insight Fitch|date=12 December 2012 |access-date=12 December 2012 }}</ref>

==See also==
* [[Mezzanine capital]]
* [[Thomson Financial League Tables]]

==References==
{{Reflist}}

==External links==
{{wiktionary|junk bond}}
* {{cite encyclopedia |last1= Yago |first1=Glenn  |editor= David R. Henderson  |editor-link= David R. Henderson  |encyclopedia=[[Concise Encyclopedia of Economics]] |title=Junk Bonds |url=http://www.econlib.org/library/Enc/JunkBonds.html |year=2008 |edition= 2nd |publisher=[[Library of Economics and Liberty]] |location=Indianapolis |isbn=978-0865976658 |oclc=237794267}}

{{Bond market}}
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{{DEFAULTSORT:High-Yield Debt}}
[[Category:Bonds (finance)]]
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[[Category:United States housing bubble]]
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