More and more of corporate America is getting rated junk. Investors, though, don’t seem to mind.
Last year, 281 new corporate bonds got a rating of BB+ or lower, generally considered the cut off of what is typically considered junk debt, according to a new analysis by bond rating firm Standard & Poors. That’s up from 59 in 2008.
Overall, 35% of U.S. companies are rated junk, that’s up from 28% in 2006.
It is normal for credit standards to loosen when the economy improves. Indeed, many have blamed tight credit conditions for the weak start to the economic recovery in the U.S. But the question is whether it has swung too quickly in the other direction.
Already, the percentage of new companies issuing debt that are getting rated junk is much higher than at the peak of other credit cycles. Back in 1987, 56% of all new debt issues were rated junk. That percentage hit 71% last year. In 2007, that figure peaked at 69%, so we’re not much higher than that now. But few think the current economic upswing is over. So the percentage of companies getting junk ratings will most likely continue to increase.
Headphone maker Beats Electronics had a junk rating before it was recently acquired by Apple. Some other well known companies that are now rated junk include California Pizza Kitchen, Green Mountain Coffee (GMCR), The Container Store (TCS), and Heinz.
Despite the low debt ratings, investors are snapping up the risky corporate debt. The Bank of America Merrill Lynch High Yield index has a yield of 4.84%, close to its all-time low.
Investors are paying up for low-rated bonds because few believe the ratings are accurate. Back in the mid-2000s, S&P and other bond rating firms gave high grades to a number of mortgage bonds and related investments that ended up either going bust or experienced high default rates. Some may think the rating firms have swung too far back in the other direction and are now too conservative.
Also, in part because there is more debt out there, there has been somewhat of a culture shift in corporate America. Corporate executives used to project their investment grade rating. These days, more and more CEOs and CFOs are happy being rated junk.
What’s more, default rates on debt rated in the B category were just 0.9% last year. That’s much lower than usual. And at a time when all interest rates are low, more investors are willing to buy into high yield bonds.
“The Federal Reserve wanted to push people into risky assets,” says Martin Fridson, a long-time high yield strategist, who recently changed his rating on the sector from “overvalued” to “way, way overvalued.” “The Fed has succeeded, but it doesn’t mean high yield bonds are priced correctly.”