Highyield debt

High-yield bonds, also known as non-investment-grade, speculative-grade or junk bonds, are fixed-income securities rated below investment grade by major credit rating agencies. These bonds offer higher yields than investment-grade instruments to compensate investors for their elevated credit and default risk. As of 2024, yields on high-yield bonds remain significantly above those on United States Treasury securities, reflecting their comparatively riskier profile within global credit markets.
The high-yield sector is an essential component of corporate finance, risk management, and investment strategy. It provides funding opportunities for companies with weaker credit standings while offering investors potentially superior returns in exchange for accepting heightened uncertainty.

Credit Risk and Default Characteristics

The principal risk associated with high-yield bonds is the risk of default — the failure of an issuer to make scheduled interest or principal payments. Because these bonds are issued by firms with lower credit ratings, investors require a greater yield as compensation for undertaking additional credit exposure.
Long-term historical averages in the United States indicate default rates close to 5 per cent. Periods of economic stress tend to elevate these levels markedly. For instance:

• during the 1989–90 liquidity crisis, default rates rose to between 5.6 and 7 per cent;
• during the COVID-19 downturn, defaults approached 9 per cent;
• recessions and deteriorating business conditions generally lead to higher rates of failure.

Default probabilities in this market are highly cyclical, responding closely to macroeconomic developments, liquidity conditions, and sector-specific shocks.
Institutional investors — including pension funds, banks, insurance companies and mutual funds — dominate the investor base for high-yield debt. Individual investors typically access this asset class through mutual funds or exchange-traded funds. Some institutional investors are restricted by internal policies from purchasing securities below certain credit ratings, limiting their participation in the high-yield segment and helping create differentiated demand structures across the credit spectrum.

Market Size and Index Coverage

The United States hosts the world’s largest high-yield bond market. In the first quarter of 2022, outstanding high-yield bonds were valued at approximately USD 1.8 trillion, representing about 16 per cent of the total US corporate bond universe. New issuance reached over USD 435 billion in 2020, reflecting the market’s crucial role in corporate financing during periods of economic uncertainty.
A variety of indices track performance within the high-yield market:

• ICE Bank of America US High Yield Total Return Index;
• Bloomberg Barclays US Corporate High Yield Total Return Index;
• S&P US Issued High Yield Corporate Bond Index;
• FTSE US High-Yield Market Index.

Investors often choose indices aligned with their risk preferences. Some prefer indices limited to BB and B ratings, while others specialise in the riskiest category, including CCC-rated and distressed debt. Distressed securities are frequently defined as those yielding at least 1,000 basis points above government bond equivalents.

Corporate Use and the Development of the High-Yield Market

Early high-yield bonds emerged as formerly investment-grade bonds whose credit ratings declined over time — so-called fallen angels. Many fell substantially below their intrinsic values as markets penalised issuers experiencing financial or operational difficulties.
A transformative phase occurred in the 1980s when Michael Milken and other financiers at Drexel Burnham Lambert helped develop high-yield bonds issued as speculative grade from inception. These instruments became a central financing tool in leveraged buyouts (LBOs) and hostile takeovers. Companies acquired through such transactions typically carried high debt burdens, often with debt-to-equity ratios of 6:1 or higher, which raised concerns about financial stability, long-term competitiveness, and employment effects.
By the mid-2000s, the nature of issuance had evolved. Over 80 per cent of US high-yield bonds issued in 2005 funded general corporate purposes rather than acquisitions or buyouts. In emerging markets including China and Vietnam, high-yield bonds gained popularity as substitutes for limited bank lending, particularly for non-state enterprises, supporting the broader development of local capital markets.

Repackaging, Structured Finance, and the Subprime Crisis

High-yield bonds can be restructured into collateralised debt obligations (CDOs), with senior tranches often receiving credit ratings above those of the underlying assets. Through this process, securities initially unsuitable for certain institutional investors can meet minimum credit requirements. However, this practice can also obscure underlying risk.
The 2007–09 subprime crisis exposed the hazards of such repackaging. CDOs backed by subprime mortgage loans and other low-quality assets became illiquid and were labelled toxic assets. Their complexity made valuation extremely difficult. As the recession progressed and defaults increased, the value of these assets deteriorated sharply. Institutions holding substantial volumes of toxic debt — including prominent investment banks — experienced severe losses, contributing to systemic instability.
Toxic assets created two significant problems within the banking sector:

• they increased asset value volatility, potentially rendering previously healthy banks insolvent;
• they encouraged risk-shifting behaviour, where distressed banks pursued speculative loans to transfer risk to depositors and creditors.

In March 2009, the United States government introduced the Public-Private Investment Partnership (PPIP) as part of broader efforts to cleanse bank balance sheets. The programme involved initiatives to purchase legacy loans and legacy securities, relying on combinations of private capital, Treasury funds, and Federal Reserve loan facilities. Although welcomed by some market participants, commentators raised concerns about hidden subsidies, distorted incentives, and resistance from banks reluctant to realise losses by selling assets at market prices.

High-Yield Bonds and Sovereign Debt in the European Union

The early 2010s saw high-yield characteristics emerge within the sovereign debt of several European Union member states as fiscal strains intensified. Greece’s debt rating was reduced to junk status in April 2010 amidst default fears. Portugal followed in July 2011, and Italy experienced downgrades in 2012 as concerns grew about debt sustainability, weak growth, and the broader banking sector deleveraging.
Despite these pressures, many European firms continued to issue high-yield bonds. By late 2012, market issuance remained substantial, reflecting demand from firms with stable financing needs even as credit ratings drifted downward. The attractiveness of high-yield markets persisted due to lower borrowing alternatives, especially in environments where traditional bank lending constraints remained strict.

Economic Role and Wider Implications

High-yield bonds fulfil an important function in global finance. They enable companies with moderate or weak credit profiles to access capital, supporting entrepreneurial activity, restructuring, and investment. They also offer investors opportunities for enhanced returns, portfolio diversification, and compensation for bearing additional credit risk.
However, the market has inherent vulnerabilities. Cyclical default patterns, sensitivity to economic downturns, and exposure to liquidity risk can amplify financial instability. Structured products containing high-yield components may disguise underlying risk, increasing the probability of systemic crises, as demonstrated during the subprime episode.