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Junk Bond ETFs Could Face Credit Risks after a Year of Prolific Borrowing

Despite the stubbornly low rate environment, exchange traded fund investors have been loath to pick up speculative-grade, junk-rated bonds. The decision may be prescient as the boom in U.S. corporate borrowing has exposed the segment to increased defaults among financially risky companies.

Source: Junk Bond ETFs Could Face Credit Risks after a Year of Prolific Borrowing

Among the most spurred ETFs of 2021, the iShares iBoxx $ High Yield Corp Bond ETF (NYSEArca: HYG) experienced $6.3 billion in outflows and the SPDR Bloomberg Barclays High Yield Bond ETF (JNK) shrunk by $3.5 billion, according to ETFdb data.

According to S&P Global Ratings, sales of low-rated “speculative-grade” debt have hit $650 billion this year, on pace to surpass all-time borrowing records with four months left to go, the Financial Times reports. The record borrowings come just after companies incurred record amounts of cash in 2020 in an bid to ride out the coronavirus pandemic.

Due to the borrowing spree, senior analysts at both Moody’s and S&P argued that the demand from investors searching for higher-yielding assets in a low interest rates environment had provided less creditworthy companies access to financing with loose lending terms. While debt defaults and bankruptcies could remain low for the short-term, the analysts warned that the easy access to liquidity might be laying the groundwork for future debt problems.

“It might not come home to roost in the next year or even longer,” Gregg Lemos-Stein, chief analytical officer for corporate ratings at S&P, told the Financial Times. “But there are clear signs of risk-taking and a lot of lower-rated issuance. We think this will lead to elevated levels of defaults down the road.”

Additionally, potentially higher inflation could push up interest rates, which also makes companies with floating-rate debt vulnerable to rising borrowing costs, a risk that threatens issuers with fixed-rate debt due to be refinanced.

“If you take a forward view, there are many more companies that are fragile,” Christina Padgett, head of leveraged finance research and analytics at Moody’s, told the Financial Times. “They have layered on a lot of debt. What if growth slows beyond what was anticipated when that balance sheet was structured? What if real rates rise or inflation remains higher for longer than we think?

“What may be manageable given today’s outlook could be unsustainable in a higher-cost or lower-growth environment,” Padgett added.

For more news, information, and strategy, visit the Fixed Income Channel.

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