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US High-Yield Credit Strategy Update: BB Bonds Are Expensive

Key Insights

This report provides an update on the US high-yield credit market, highlighting the view that Double-B (BB) bonds are particularly expensive relative to their peers.

• BB Bond Valuation: BB bonds are considered rich across the credit spectrum when compared to BBB and B-rated bonds. Investor demand seeking haven in higher-quality paper contributes to this richness.
• Recommendation Change: The equilibrium spread gap between BB and B-rated bonds remains wide. Consequently, Citigroup reverses its recommendations, advising an underweight position in BB-rated bonds and an overweight position in B-rated bonds.

Bloomberg High Yield Index Impact: Warner Bros. Downgrade

The recent downgrade of Warner Bros. Discovery (WBD) by major credit agencies to high-yield status has significant implications for the high-yield index.

• Initial Impact (July):
  • Approximately $31.8 billion (estimated) of WBD debt is expected to enter the Bloomberg High Yield Index.
  • WBD becomes the largest issuer in the index by par and one of the largest by duration and market value.
  • Due to a tender offer and upcoming bond maturity, tracking error might be somewhat limited in July.
• Post-Tender Impact (August):
  • Removal of bonds via the tender process is estimated to reduce the index exposure to $16.3 billion, placing it among the top emitters by par/market value but less dominant.
  • WBD remains influential due to the long duration of its bonds, crucial for a duration-starved market.
  • Debts structure will likely adjust post-merger and new issuance, adding further uncertainty to its long-term index weight.

Market Dynamics & Valuation

• Decompression: Significant credit quality decompression continues between BB and single-B rated bonds since mid-February.
• BB Richness: While BB yields are high (OAS ~195bp), they compared favorably to the very tight historical range of dispersion. BB bonds provide cheap income especially for tactical investors.
• Valuation: The high-yield market has largely recovered from the "Liberation Day" lows, but credit quality disparities persist.

Factor Analysis

The report utilizes a factor framework considering different credit qualities. Double-B and single-B bonds within a "Regular Way" (excluding distressed debt, certain sectors, and curve extremes) are analyzed. The key finding is the pronounced richness of the Regular Way BB factor.