Key takeaway: Sharp increase in credit spreads could hit highly leveraged companies

Do absolute or relative changes in yield spreads matter more? The recent increase in yield spreads between high-yield companies and Treasuries, as highlighted by the ICE BofA High Yield Index Option Adjusted Spread, has been similar in magnitude to the increase during the August 2024 market turmoil.

The HY spread in 2024 peaked on Aug 5 at 3.93 - still over 50bps higher than the recent 13 March level of 3.4. But during the Aug 2024 meltdown HY spreads increased by 26% over a 15-day period, compared to 28% in the recent widening.

Why might relative changes matter? Assume Treasury yields have remained the same over the spread-widening period. If a HY company borrowed $ 1 000 000 at e.g. a 3% interest rate, its annual interest burden would be $ 30 000. If the rate increases from 3% to 4% then the interest burden would increase from $ 30 000 to $ 40 000. This is a 33% increase in interest cost.

If you are a company operating with a high amount of leverage, and/or interest repayment costs form a large part of your expenses, or you couldn’t easily cut other costs or increase profits, a sudden widening of HY spreads could lead to a significant increase in interest costs which could limit your capacity to refinance debt or cause liquidity problems.

Theme: Credit Spreads

Tags: Corprate Credit, Bond Spreads, High yield, ICE BofA

Data from: St Louis FRED

Disclaimer: Not financial advice. Please review original sources, conduct your own analysis and due diligence, and make your own investment decisions. Author takes no responsibility for the accuracy or inaccuracy of this data.

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