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Junk Bonds Are Starting to Crack as Stock Selloff Persists

The cost to protect against losses on junk bonds rose Friday to its highest level since December 2016.

By Molly Smith and Austin Weinstein

(Bloomberg) --After weathering the stock-market turmoil all week, junk bonds are finally starting to show some cracks.

The biggest exchange-traded fund that buys the debt clocked its worst day in more than a year on Thursday. Investors pulled money from high-yield bond funds for the seventh week in nine. That’s driving up yields for some of the market’s biggest 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 Friday to its highest level since December 2016. In Asia, speculative-grade corporate notes registered a third week of losses. Average prices of the securities fell to the lowest level since June 2016, according to ICE BofAML Asian Dollar High Yield Corporate Index, after dropping below par this month.

Fund managers aren’t yet panicking. After all, the extra yield demanded to hold U.S. junk bonds instead of Treasuries -- at 3.46 percentage points on 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 selloff.

“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.

U.S. stock futures fluctuated on Friday, following continued selloffs in Asian and European markets.

 

The weakness in junk started in the most actively traded instruments, mainly ETFs and derivatives known as credit-default swaps, which insure investors against losses. Investors have been snapping up those contracts all week, pushing the cost to the highest since December 2016.

But by Thursday, more and more sales of underlying bonds were starting to populate the bond-price reporting system known as Trace:

  • A $2.25 billion bond issued by energy explorer California Resources Corp. has dropped 6 cents on the dollar the past two days to 78. That pushed the yield on the debt, rated in the lowest tier of speculative grade, to 14.5 percent.
  • Frontier’s $2.18 billion of notes due in 2022 fell 3 cents to 78.5, with the yield rising to 17.5 percent.
  • Community Health’s $1.2 billion of debt due in 2020 dropped 2.25 to 84.9 with the yield topping 14.7 percent.

Matt Kennedy, a high-yield manager at Angel Oak Capital Advisors, said he’ll be looking to buy the dip on some bonds. “Guys have been coming in showing bids for a variety of names despite the move,” he said. “It doesn’t feel panicky.”

 
--With assistance from Kailey Leinz, Daniel Flatley, David Yong and Kenneth Pringle.To contact the reporters on this story: Molly Smith in New York at [email protected] ;Austin Weinstein in New York at [email protected] To contact the editors responsible for this story: Nikolaj Gammeltoft at [email protected] Shannon D. Harrington, Dan Wilchins

 

TAGS: ETFs
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