With the rising risk of recession, T Rowe Price believes high yield bonds will generate a decent yield for the rest of the year, due to strong earnings and balance sheets.
“During the pandemic, companies have been very conservative in managing their balance sheets given the uncertainty, resulting in healthier interest coverage ratios and leverage ratios,” said Ramon Maronilla, fixed income specialist, T Rowe Price, during an interview with FSA.
“The other thing is that central banks have unleashed massive amounts of stimulus, including very low interest rates as well as the quantitative tightening, leading many companies to take advantage of the robust capital market conditions to refinance their debt to extend their maturities.”
As a result, he noted that there is only a small amount of high yield debt coming to maturity from 2022 to 2024, with most scheduled for later dates.
“Even if companies are not very well funded for the next couple of years, the chance of going into a default is a lot less because they already have completed their rounds of financing,” said Maronilla.
He also noted that the previous wave of defaults during Covid-19 has eliminated weaker companies, leaving strong survivors which can withstand “very challenging environments”.
Although the low default rates for US and Europe high yield are expected to rise, he thinks valuations and yields in the asset class provide an adequate cushion in an environment of a mild recession.
The sector has suffered tremendously as the government attempted to curb speculation and reduce leverage across the sector.
This has caused a larger-than-expected scale of defaults in the industry, causing homebuyers and investors to lose confidence and eventually drive the industry into a vicious cycle, explained Maronilla.
“Although the government is implementing a number of measures to try to break the vicious cycle and stabilise the market, there is still a lot of work that needs to be done,” he added.
“In the offshore markets, for example, more than 70% of the borrowers are trading at distressed levels, indicating significant market concerns about contagion and default risk.”
Among Chinese property developers, Maronilla expects both state-owned firms and those with stronger balance sheets to survive, while valuations have already priced in for private companies that are already trading as distressed.
Meanwhile, mortgage boycotts and stalled construction projects have recently stirred up concerns in the Chinese financial services industry that it may become the next victim.
Yet Maronilla believes mortgage defaults and delinquencies are still quite small relative to the overall market.
“At the same time, the banks are very well capitalised with a lot of liquidity buffers to reasonably manage even a worst-case scenario with more defaults,” said Maronilla.
He believes mid-sized banks may be the most vulnerable as they have a smaller capital buffer when compared with state owned banks.
They also rely more on wholesale funding in interbank borrowing and the bond markets, which means that if one bank fails, it could lead to some level of contagion.