After taking on roughly $1.87 trillion of low-cost debt during the pandemic,¹ high-yield bond issuers are hurtling toward a "maturity wall" as many of those bonds and loans come due over the next five years.

These companies will need to repay the debt with cash on hand or refinance it at rates potentially much higher than when they initially borrowed—which could increase their risk of default should the economy contract and profits decline. But just how likely is a massive wave of defaults? Let's take a look.

Rather than retiring their loans, high-yield issuers regularly refinance their debt, kicking the proverbial can down the road. This strategy worked well when interest rates were near zero during the global financial crisis and again during the COVID-19 pandemic. But with the Federal Reserve suggesting in March that it would hold rates higher for longer than originally anticipated, it's likely that high-yield issuers' new debt will cost more than what is being replaced.

Refinancing risk is a legitimate concern and one we're watching closely, but we see three reasons to remain cautiously optimistic:

Many high-yield issuers have been refinancing their debt well in advance of looming maturity deadlines. Over the course of 2023, for example, high-yield borrowers reduced their debt coming due in 2024, 2025, and 2026 by 57%, 43%, and 14%, respectively.

While total outstanding debt coming due in the next two years may be larger than that of the previous six years, the percentage of debt coming due looks to be fairly consistent.

High-yield defaults rose to 5.6% in 2023—the highest level since 2020. However, credit rating agency Moody's believes they'll peak below 6% this year before reverting to their historical average of about 4%. That's in part because investors buoyed by a brightening economic picture remain eager to provide financing. In addition, companies have established alternative ways to address debt-coverage problems, such as distressed exchanges, in which investors agree to less than what they were originally entitled to. (Distressed exchanges still constitute a default, but they tend to result in higher recovery values for investors than when an issuer defaults by missing an interest or a principal payment or by filing for bankruptcy.)

We still believe investment-grade bonds (those rated BBB or higher²) are most appropriate for the majority of investors. For one thing, their relatively high credit quality means they should be able to withstand higher borrowing costs.

That said, if you're hunting for more yield and are willing to accept the heightened risk of high-yield bonds, we suggest sticking with higher-rated issuers. Research has found that BB-rated bonds—the highest high-yield rating—have default rates below those of B-rated and well below those of bonds rated CCC or worse.³

You could also opt for a high-yield bond fund that focuses on the BB-rated area of the market. Doing so could add more diversification to your bond portfolio than lower-rated bonds would and may help lessen the impact on your portfolio should an issuer default.