Three overlooked risk factors in high-yield credit
14 NOV, 2025
By Mauro Ratto, Co-Founder and Co-Chief Investment Officer, Plenisfer Investments (part of Generali Investments)
The current cycle is marked by its exceptional length, with spreads near historic lows and very low default rates. In this environment, the high-yield credit segment appears particularly solid. But is it really? A closer look at today’s dynamics reveals three risk factors the market tends to underestimate.
The first is the correlation between lower default frequency and the growing prevalence of unconventional corporate liability-management transactions.
Among these are “uptiering” operations, increasingly common in the United States and now also in Europe. Through these transactions, a financially strained company enters into a new financing agreement with one or several “last-resort lenders”—typically private debt funds—who, taking advantage of the limited or virtually nonexistent contractual protections on existing debt (bonds and often bank loans), provide new secured debt that sits at the top of the capital structure, i.e., with priority repayment over existing creditors. In the short term, this allows the company to avoid default and enables majority shareholders to retain control—at the expense of existing creditors whose claims effectively become subordinated and therefore devalued, even without an immediate default.
The rising significance of these transactions must also be assessed in light of the expanding private-debt market, currently estimated at around $2 trillion, as the abundance of available capital exponentially increases the risk of deteriorating credit quality and weakening lending standards. The recent collapse of auto-parts manufacturer First Brands illustrates how, in the current market environment, a company with questionable governance, financing, and collateral can pursue aggressive borrowing policies and, when facing a liquidity crisis, postpone bankruptcy for a long period through opaque financial maneuvers, including off-balance-sheet items amounting to several billions of dollars.
Thus, the collapse of First Brands highlights the material risks associated with lack of transparency in off-balance-sheet operations and complex trade-finance arrangements, which can generate substantial losses and reputational damage for major financial institutions. Moreover, the company’s failure may well represent a warning signal—the first evidence of a vastly underestimated risk that could spread across the market, given its size and the fragility of the underlying assets.
In this context, only a thorough analysis of prospectuses and credit-protection covenants, combined with an assessment of management and ownership quality, allows investors to adequately quantify risks that are currently largely underpriced.
Meanwhile, as unconventional liability-management transactions proliferate, litigation related to them is also rising. In the “Serta Simmons” case, a U.S. appellate court ruled that a specially prioritized debt offering to a select group of creditors violated the principle of pro-rata repayment and the implied covenant of good faith. The court stressed the limits of liability-management operations that alter creditor hierarchy without clear consent from all involved parties. This is the second risk factor: the growing awareness that subordination is no longer guaranteed could trigger a crisis of confidence, similar to what occurred during the subprime mortgage crisis. A contagion effect could quickly spread turmoil to the broader high-yield bond market.
In this respect, the case of the Ardagh Group is instructive. The “financial acrobatics” linked to these liability-management operations distort the traditional priority hierarchy, which in a typical debt restructuring would imply the wipeout of equity. Ardagh, an Irish metal- and glass-packaging manufacturer in distress, recently restructured its balance sheet through a debt-for-equity swap covering approximately $4.3 billion of debt out of a total exceeding $10 billion. In this deal, senior secured creditors are well protected, while senior unsecured bondholders receive 92.5% of the equity in a private company and gain control; meanwhile, PIK noteholders are heavily diluted, receiving only 7.5% of the equity. Notably, Ardagh’s current shareholders will receive roughly $300 million, of which a little over $100 million goes to the majority shareholder, in exchange for relinquishing their stake. The deal has already triggered legal challenges from some PIK creditors, who argue that it violates the traditional order of priority between debt and equity, but it remains a clear example of how, in high-yield restructurings, the boundary between debt and equity can become extremely blurred.
The third risk factor in high-yield credit relates to the growing phenomenon of issuances designed to distribute dividends to shareholders, known as “dividend recapitalizations.” Historically marginal within total high-yield issuance, these operations gained significant importance in 2025, reaching 8% of European high-yield issuance and roughly 5% in the United States in early summer. At the same time, leveraged buyouts and IPOs of private-equity-backed companies have declined: despite high equity-market multiples, funds struggle to bring companies to market. As a result, their ability to return capital to investors has weakened—a difficulty mitigated through dividend recapitalizations. These transactions allow funds to distribute cash without giving up control, though at the cost of increasing overall leverage and the associated risks to debt sustainability and future cash flows.
This trend requires investors to pay closer attention to the real quality of debt and the sustainability of the issuer’s capital structure, looking beyond ratings or spread levels when assessing investment opportunities.
Conclusion
The vulnerabilities identified remain under close observation. Ultimately, persistent conflict among different creditor classes harms the credit market itself: the resulting uncertainty leads to higher capital costs, ultimately penalizing private-market participants who rely on credit to support their activities. The deterioration of this ecosystem will be heavily influenced by macroeconomic conditions: any downturn could act as a catalyst for a prolonged phase of financial stress.
Now more than ever, financial leverage, covenant quality, and contractual protections in credit transactions are of fundamental importance. The purpose of the debt and, above all, the presence of a high-quality, transparent management team capable of maintaining market confidence are decisive factors in building solid and resilient credit portfolios.
An active and flexible management approach, supported by quantitative and qualitative analysis, allows investors to avoid excessive exposure to instruments that only appear safe, seize opportunities arising from mispriced risk, and preserve capital in periods of heightened volatility or macroeconomic tension.
