By Katy Burne, Gregory Zuckerman and Rob Copeland
The oil bust is exposing cracks in the $1.3 trillion junk-bond
market, putting pressure on a key source of corporate financing and
potentially crimping economic growth.
U.S. junk-bond prices have fallen 8% since late June, according
to data from Barclays PLC. One-third of that drop has come this
month alone, putting the market on track for its worst annual
performance since the financial crisis.
While much of the stress has been in the energy sector on the
heels of the sharp decline in oil prices, lately the woe is
spreading across the junk market.
Each of the 21 high-yield sectors in a U.S. junk-bond index
tracked by J.P. Morgan Chase & Co. registered losses in the
five days ended Dec. 9.
"Oil prices have crushed the energy sector and it's leaking
elsewhere," said Andrew Herenstein, co-founder of Monarch
Alternative Capital LP, which manages $5 billion and is among the
largest investors in distressed debt.
Debt is generally deemed to be distressed when investors view it
as at high risk of missing bond payments or of a restructuring, at
least at some point.
A pullback from junk bonds is often a harbinger of a broader
reassessment of risk across financial markets, raising the
possibility that investors could turn more wary of stocks and other
assets.
Skeptics warned earlier this year that the junk market was
becoming overheated, pointing to the risk of a larger-than-expected
retreat.
A raft of postcrisis rules have hit securities-dealing banks,
hampering the ability of those middlemen to cushion a selloff,
especially in risky assets. Many say the changing role of those
dealers is exaggerating the price drops, raising the risk of
indiscriminate selling, or "fire sales."
"The problem with high yield is often that investors have to
sell what they can, not what they want to," said Peter Tchir,
managing director at Brean Capital LLC, an investment bank and
asset manager.
The junk selloff comes as investors are uneasy about the global
economy and Federal Reserve interest-rate increases that many
expect to begin next year.
Junk bonds, like stocks, have mostly proved resilient, bouncing
back after modest pullbacks. Both these bonds, and stocks, could
again resist a deep drop.
But some are betting this current junk-bond decline will deepen,
if investors are caught off guard by a slowdown in growth, a
corresponding rise in defaults and dealer difficulty in absorbing
all the selling.
Joshua Birnbaum, the ex-Goldman Sachs Group Inc. trader who made
bets against subprime mortgages during the financial crisis, now
has more than $2 billion in wagers against high-yield bonds at his
Tilden Park Capital Management LP hedge-fund firm, according to
investor documents.
Some investors worry the selling could feed on itself, sending
up yields, stalling issuance and prompting restructurings or
bankruptcies, analysts said.
Weakening demand for junk bonds has investors demanding a more
generous yield to purchase these bonds rather than safer debt. Junk
bonds now trade at a yield of 5.28 percentage points above yields
of comparable U.S. Treasurys, up from 3.23 points at their June low
for the year.
Investors' "panicky logic" also includes some "nervousness"
ahead of a meeting this week when the Fed may provide updated
signals on interest rates, said Anthony Valeri, investment
strategist at LPL Financial, which directly oversees or advises on
$415 billion of assets.
U.S. high-yield bonds have returned just 0.78% this year,
including price action and dividends, according to Barclays,
putting the debt on track for its worst showing since 2008. Junk
bonds returned 7.44% last year and 15.8% in 2012, Barclays
said.
Since June, investors have yanked more than $22 billion from
funds dedicated to junk bonds, according to fund tracker Lipper.
Investors withdrew an additional $1.9 billion in the latest week
ended Wednesday.
To be sure, the factors that have supported the junk-market
rally since 2009 remain largely in place. The U.S. economy is
growing, with job creation expanding last month at the fastest clip
since the tech boom of the late 1990s, and interest rates and
defaults remain low. Despite the issuance slowdown, financing
remains broadly available and defaults are low.
What's more, high-returning investments remain scarce amid low
yields on safer bonds, meaning that many investors retain the
"reach for yield" mentality that favors risk taking in
income-generating securities.
"These bonds have been beaten up tremendously and they're not
all going to default," said Brendan Dillon, senior investment
manager at Aberdeen Asset Management Inc. Mr. Dillon said he has
added 1% to 2% to the firm's energy exposure within its high-yield
funds because those bonds were oversold. Still, traders are
scurrying to reposition.
Daily high-yield trading volumes earlier this month reached an
average of $8.2 billion, said J.P. Morgan, just shy of their
October record and up from the daily average of $5.6 billion in
2013.
Junk-bond issuance has slowed. Companies such as Dallas refiner
Alon USA Energy Inc. have pulled deals. Units of casino and resorts
operator Parq Holdings LP and food and beverage giant JBS USA also
canceled planned bond sales this month, according to Leveraged
Commentary & Data.
JBS didn't respond to a request for comment. Parq had no
comment.
Still, some see a buying opportunity at hand. Investors will
"try to sell all or a lot of their energy holdings somewhat
indiscriminately...and when the dust settles some investors have an
opportunity," said David Breazzano, chief investment officer at
money manager DDJ Capital Management LLC, which oversees about $8
billion.
Matt Wirz contributed to this article.
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