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In finance, a high-yield bond ( non-investment-grade bond, speculative-grade bond, or junk bond) is a bond that is rated below investment grade by credit rating agencies. These bonds have a higher risk of default or other adverse but offer higher yields than investment-grade bonds to compensate for the increased risk.
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.:208 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%.:209 A recession and accompanying weakening of business conditions tends to increase the possibility of default in the high-yield bond sector.
Some institutional investors have 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.
Indices for the high-yield market include:
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 over equivalent government bonds.
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 (LBOs) and .:208 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. (2025). 9780077246129, McGraw-Hill/Irwin. ISBN 9780077246129
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.
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.
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 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. , by increasing the variance of banks' assets, can turn otherwise healthy institutions into Zombie bank. Potentially insolvent banks made too few good loans creating a debt overhang problem. Alternatively, potentially insolvent banks with toxic assets sought out very risky speculative loans to shift risk onto their depositors and other creditors.
On 23 March 2009, U.S. Treasury Secretary Timothy Geithner announced a 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. 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 Lending Facility (TALF). The initial size of the Public Private Investment Partnership is projected to be $500 billion.
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. 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. 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 will hurt the stock price of distressed banks. Therefore, such banks will only sell toxic assets at above market prices.
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 . 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.
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