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By Eric Jacobson | 06-13-2013 03:00 PM

How Healthy Is High Yield?

The risk of corporate defaults is low, and compared with years past, companies are finding optimal capital structures, says BlackRock's James Keenan.

Eric Jacobson: Hi. I'm Eric Jacobson with Morningstar. We're here today at the Morningstar conference with Jim Keenan of BlackRock. Jim manages BlackRock's high-yield and leveraged loan business, and I just want to say thanks a lot, Jim, for joining us. Appreciate it.

James Keenan: Thanks. Good to see you.

Jacobson: So, with things that have been going on in the bond market, one of the big questions right now is valuation in high yield. Can you talk a little bit about where you think things stand and what the risks are and aren't as far as what people are worried about?

Keenan: Obviously, there has been a lot of volatility in the overall bond markets, and I think the cause of that volatility is different than what we were fearful of in 2010 and 2011. The reality is that the Fed is talking about reducing its asset-purchase program, or the tapering language that everyone is talking about. But the reasons for that is because the economy is actually doing better. When you think about high-yield bonds, it’s about lending to companies. So the risk to a high-yield bond, that spread that you charge above a five-year U.S. Treasury to lend to that company, really is the probability of default of that company and what your potential recovery might be.

So, those spreads are still wide right now. In an improving environment, the companies are doing better. So, the volatility and sell-off of the markets have been because the curve is steepening because the markets are doing better. The velocity of the move, I think, is starting to unnerve some of the markets. But with regard to it as it stabilizes where the health of the high-yield market is, it’s still good, and you look at valuations--and sometimes people look at the overall yield--but you have look at necessarily the spread risk to it because that spread is the premium you're getting from going to Treasuries into high yield. It’s still got a duration [a measure of interest-rate sensitivity] component to it, and that’s the risk. But high yield is still trading at 5.5% over Treasuries. You have a high-yield bond at 6.5% where the market trades, and relative to a five-year Treasury that's up 1%. I mean, the high-yield market doesn't set Treasury rates. Treasury rates are set by growth expectations and inflation expectations, and they are very low right now, because we're still growing through a deleveraging.

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