Why are yields-to-worst at historic lows for high-yield debt?

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Nov. 26 2019, Updated 12:16 p.m. ET

What is the yield-to-worst?

The yield-to-worst is the lowest and most realistic yield that a bondholder can expect. Sometimes, a bond trades at a premium to par value in the secondary market. This happens when the prevailing rates of rates are lower than the yield at which the bond was originally issued. At this point, there is an incentive for the issuer to retire the existing costlier debt and issue new debt at the prevailing lower rates of interest, as long as issuance costs are lower than the benefit the borrower receives from refinancing the debt. Bonds with an embedded call option are usually issued at higher yields to compensate the bondholders for the risk of call. Municipal bonds (MUB), mortgages, and mortgage-backed securities are usually callable.

The yield-to-call (or YTC) is the yield that the bondholder would receive if the issuer exercises the call option. The yield-to-maturity (or YTM) is the yield that the investor would receive if the bonds are held to the stated maturity date. The yield-to-worst is the lower of the YTC or the YTM.

Yields-to-worst in the week ending June 20

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The average semi-annual yield-to-worst for high-yield bonds at 4.86% on June 20 (as measured by the BofA Merrill Lynch U.S. High Yield Master II Semi-Annual Yield to Worst), was at a historical low, as a number of high-yield debt (HYG) issuers took to refinancing existing costlier debt. The BofA Merrill Lynch U.S. High Yield Master II Semi-Annual Yield to Worst, which has data on high-yield (JNK) bonds going as far back as 1996, has never had a lower value.

With yields at record lows, more bonds are trading at a premium. Exercising the bond’s call option (if any) becomes advantageous for issuers in this environment. As a result, this impacts the bond’s yield-to-worst, which tends towards the bond’s lower YTC rather than the YTM.

In the following sections, we’ll continue our analysis of the key trends in the corporate debt market last week, focusing on leveraged loans (SNLN) and corporate investment-grade debt (LQD). Please continue reading the next section in this series.

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