The high-yield bond market is enjoying a “stellar year” according to Coutts, yet there are indications that it may be over-heating.

 The pursuit of sizeable returns resulted in the issuance of a record breaking US$ 45 billion high-yield dollar-denominated bonds last month. This brought the year-to-date total up to US$ 261 billion, comfortably passing last full-year’s total of US$ 246 billion, said Coutts in a report this month, 'A stellar year for corporate bonds continues'. 

Emerging market bonds have also been much in demand. Emerging market corporate bonds surpassing US$ 1 trillion for the first time in September. Which, according to JPMorgan, represents an annualised growth rate of 27 per cent. The market has effectively doubled since 2008 and tripled since 2005.
 
On 10 September 2012, US$18.95 billion of new corporate bonds changed hands, a single day record according to Coutts.
 
However, while newly issued bonds continue to do comparatively well, outperforming risk-free government bonds to-date, the quality of issuer is deteriorating rapidly. The Coutts report warned “many of the new high-yield issues are rated low single-B or even CCC, the lowest rating. Usually this is a clear sign of overheating in the high yield market.”
 
As further cause for concern there has been a steady decline on high-risk yields, with 6.6 per cent and lower being the normal for B - junk bonds, making them high-yield in name only, according to the Barclays high-yield index.
 
The upsurge of new bond issuance is in part a response to the lack of credit flow. “Confidence in the global financial system remains exceptionally fragile,” the IMF said. “Bank lending has remained sluggish across advanced economies” and increased risk aversion has damped capital flows to emerging markets. Companies are increasingly looking towards high-yield bonds, instead of venture capital or indeed banks, as a way of paying off debt and gaining leverage.
 
The considerable demand for high-yield, in spite of these factors, is a direct consequence of the poor return on higher-quality, better credit-assured bonds. Major government bonds and investment grade corporate bonds have struggled to offer much in the way of return to investors, whereas high-yield and emerging market bonds delivered the fourth positive monthly return in a row, according to Coutts. Making them among the best performing financial assets globally year-to-date.
 
Yields on investment grade dollar and euro-denominated corporate bonds have continued to fall to all-time lows of 2.84 per cent and 2.43 per cent respectively, according to Coutts. BBB corporate bonds outperformed higher-rated bonds in September, delivering returns of between 4.5 per cent and 5.5 per cent in the third quarter alone. Emerging market bonds denominated in local currency have performed particularly well, with double digit yields across the board.
 
The influx of demand for high-yield has allowed some underperforming companies to go about refinancing potentially bad debt at record low levels of interest. However, the rate of high-yield corporate defaulting is relatively low, according to the US credit rating agency Standard & Poor’s it stands at 2.8 per cent for the last year as opposed to the historical norm of 4.5 per cent.

Lowered borrowing costs, and increasing flexibility on the date of maturation, has led to a reduced risk of default. It is hard to judge whether this will continue, New York based rating agency Moody’s, make the rate of speculative-grade debt defaulting last quarter to be at it’s highest for two years, up 1.2 per cent on this time last year.