Junk bonds stung by stock market misery

The biggest ETF that buys the debt dropped to the lowest level since November 2016


NEW YORKAfter weathering the stock-market turmoil all week, junk bonds have started to crack.

Bonds of energy producers, healthcare companies and telecommunications providers that finance themselves with speculative-grade debt tumbled for a second day last Friday. That pushed up borrowing costs for companies that have been trying to fix debt-laden balance sheets, and it’s causing some companies to sweeten terms on new debt they’re selling.

“We’re really flipping from a positive economic scenario to a negative economic scenario,” said Ben Emons, chief economist and head of credit portfolio management at Intellectus Partners LLC in Los Angeles.

“That takes its toll immediately — not only in equities, but it starts to become an issue in high yield.”

The biggest exchange-traded fund (ETF) that buys the debt dropped to the lowest level since November 2016, after clocking its worst day in more than a year last Thursday. Further adding to the pain was oil’s worst week in almost a year, with crude dropping below US$60 (RM236.40) a barrel for the first time this year. Investors pulled money from high-yield bond funds for the seventh week in nine.

The market weakness is driving up yields for some of the biggest junk-rated borrowers, including hospital chain Community Health Systems Inc, energy company California Resources Corp and rural phone company Frontier Communications Corp.

The cost to protect against losses on junk bonds rose last Friday to its highest level since December 2016. High-yield debt markets in Europe and Asia slumped. Fund managers aren’t yet panicking. After all, the extra yield demanded to hold US junk

bonds instead of Treasuries — at 3.46 percentage points last Thursday for a benchmark Bloomberg Barclays Index — is still well below the average of the past five years. But some were concerned that continued pressure could trigger a broader sell-off.

“There’s a point at which you can’t avoid the pressure in equity markets and it starts to bleed through to high-yield” bonds, said Noel Hebert, an analyst at Bloomberg Intelligence.

The bleeding was evident last Friday, when Flexi-Van Leasing Inc sold US$300 million of second-lien notes at a significant discount with strengthened protections for investors, according to a person with knowledge of the matter, who asked not to be identified as the details are not public. Borrowing less than the face value of the debt, known as original-issue discount, reduces proceeds for the company while increasing the yield for investors.

Apex Tool Group LLC, a manufacturer of hand and power tools, had to offer investors a 9.001% coupon — above initial talk in the range of 8.75% to 9% — to sell its US$325 million issue, according to a separate person with knowledge of the transaction, who also requested anonymity discussing a private matter. The company is also marketing a loan sale, with commitments due today.

US stocks ended their worst week in two years on a positive note, after sell-offs continued in Asian and European markets.

Though volatility has been shaken from its prolonged slumber, it’s too soon to say whether the current shock will lead to tighter availability of credit and a subsequent increase in credit losses, Bank of America Corp strategists led by Oleg Melentyev said in a report last Friday. Since relative valuations haven’t changed much, the strategists recommend buying the dip in CCC bonds as well as spread curve flattening trades in BB levels. — Bloomberg