Five years after the run on the UK bank Northern Rock, companies lacking blue chip status are struggling to extract loans from banks more interested in their own survival than backing expansion.
As a result, companies are turning to the capital markets to secure loans from wealthy investors and institutions. They are paying interest charges of between 5.5% and 7% - a fat premium to the nearly zero return on savings accounts and government bonds.
To be sure, yields on high yield bonds – or junk, as it was once called – look less enticing than the 15% on offer three years ago. But those yields reflected fears that the global banking system was close to collapse. These have now receded, making high yield safer.
Initiatives by European and US central banks to print money, refinance debt and keep interest rates low adds to the allure of high yield, now economies are poised to improve.
The quality of companies issuing higher yield debt is better than in the past, and much better than during the credit boom. Over the summer Icap, a money broker, offered 5.5% and Primary Health Care offered 5.4%. Budget hotel Mr and Mrs Smith is paying 7.5% or 9.5% for people willing to accept free hotel stays as payment.
Other companies have been seeking variable-rate loan finance, once the preserve of the banks. The spreads they offer are attractive, given that payments would rise in line with any future rise in interest rates to choke off inflation.
This year has also seen rising demand for asset-backed securities, where interest charges are covered by streams of income from sources ranging from credit cards to timber harvests. Yields for esoteric offerings can range up to 6%.
One of the more interesting proposals of the summer involved an attempt by US performing rights company, Sesac, to structure a $300 million bond secured by royalties from songs by Bob Dylan. It is easy to scoff, but royalties from Dylan songs offer an income of a quality vastly superior to sub-prime mortgages issued to US families who never had a chance of servicing them during the credit boom.
Companies are also willing and able to service their debt promptly to maintain their reputation. Often, they pay investors compensation to redeem bonds early when cheaper debt becomes available. Over 10 years, US annual default rates have averaged 5%, with 2% nearer the mark in recent years.
Research carried out in the US by Braddock Hickman in the 1950s and Michael Milken of investment bank Drexel Burnham Lambert in the 1970s set the high yield bandwagon rolling.
It showed that portfolios of high yield debt easily outperformed bonds with a credit rating over time. This remains the case following the run on Northern Rock. According to Kames Capital, US high yield bonds have nearly matched equities over the long term, and experienced a far less volatile performance.
The argument that investors should divert cash out of savings accounts and sovereign bonds and into packages of high yield and variable-rate loans has become compelling.