High Yield and Distressed Debt

High Yield (HY) bonds are debt instruments with a rating below investment grade (BB+ and below according to S&P). HY issuers are younger or more leveraged companies, companies with higher business risk, companies after LBO. The HY market in the USA amounts to about $1.4 trillion, in Europe — about €400 billion. This is an important source of financing for medium and large businesses without access to the investment-grade market.

Characteristics of HY bonds. The spread over the risk-free rate is a key indicator of risk appetite. Historically: HY index spread is 300-400 bps during calm periods, 700-1000 bps during a recession, 2000+ bps in a crisis. OAS (Option-Adjusted Spread) adjusts for the value of call options, which HY bonds often have. Yield-to-Worst (YTW) is the yield in the worst-case scenario (early call). Recovery Rate upon default in HY: historically 40-45% for senior secured, 20-30% for senior unsecured, about 10% for subordinated.

Covenant protection: HY bonds traditionally have stricter covenants than leveraged loans in cov-lite structures, although the trend toward covenant loosening has affected HY as well. Callability: most HY bonds are callable — the issuer can redeem them at a predetermined price. The Non-Call period usually lasts 3-4 years, then follows the call schedule with a gradual reduction in the premium.

Distressed Debt is the debt of companies in financial distress. Two types of strategies: Loan-to-own — purchase of debt with the goal of gaining control over the company through bankruptcy. Distressed trading — short-term speculation on discounted debt with the aim of selling before restructuring. Distressed investing requires deep legal understanding: the absolute priority rule in the US (US Bankruptcy Code Chapter 11), differences in the rights of secured vs unsecured creditors, DIP-financing (Debtor-In-Possession) during bankruptcy has super-priority.

Analysis of HY and distressed. EBITDA Coverage, Leverage Ratio, FCF generation, Liquidity Runway — standard credit metrics. Stress-testing: how much can EBITDA fall before default? Asset coverage: the value of assets relative to debt (liquidation scenario). Covenant headroom: how close is the company to breaching covenants? Maturity schedule: is there a "maturity wall" in the next 2-3 years?