The credit market is humming— and that has Wall Street on edge

Concerns mount that a frothy market is concealing signs of excess; sudden bankruptcies rattle investors

- Matt Wirz & Sam Goldfarb

U.S. credit markets are running hot—maybe too hot.

Investors are gobbling up corporate debt like it is going out of style—even though the rewards, by some measures, are lower than they have been in decades. The frothy mood has some on Wall Street worried that the market is priced for perfection and ripe for a fall.

That is why any bad news is touching a nerve and raising the question of whether something more profound is ailing American borrowers. Two sudden bankruptcies in the auto world—of a subprime lender and a parts supplier—have triggered those conversations among bond investors and analysts.

So far, there is no sign of wider fallout—and each of those situations had unique characteristics that don’t point to broader trends. But combined with other challenges, such as persistent inflation and rising defaults in a hot Wall Street segment known as “private credit,” it is enough to give longtime traders pause.

“There’s been a very positive investment environment for a long time, with a large amount of money and a lot of optimism,” said Howard Marks, co-chairman of investment firm Oaktree Capital Management, which specializes in credit investing. He said that can lead to high pricing and declining quality. “The worst loans are made at the best of times.”

High-yield bond analysts at Barclays compared the current situation—with valuations so high and signs of stress emerging—to being in a Star Wars garbage chute with Princess Leia and Han Solo and “the walls compressing on all sides”.

One concern is that lending to riskier borrowers has been growing for years, first through traditional bonds and loans, then in the form of private credit and the revival of complex asset-backed debt. The longer that credit boom lasts, the more likely it is that defaults will rise. Likewise, the higher the valuations of corporate bonds and loans, the more susceptible they become to selloffs.