Companies Not Shying From Hard-To-Sell Junk Debt

Bloomberg

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Bond investors are losing their aversion to difficult-to-trade corporate debt that handed them some of the biggest losses in the credit crisis.

The extra yield note buyers demand to own older, smaller junk bonds that trade infrequently has shrunk to an average 0.25 percentage point this month from more than 1 percentage point a year ago, according to Barclays Plc data. JPMorgan Chase & Co. money manager Jim Shanahan said he's preferring "good credit quality and less liquidity" when picking bonds, while Howard Marks, the head of distressed debt investor Oaktree Capital Group LLC, said he's finding bigger potential gains in private, less-traded debt.

The evaporating premium for illiquid assets is showing the depths to which money managers are reaching to boost returns after a five-year rally that pushed relative yields on junk bonds to the least since August 2007. With Federal Reserve monetary policies suppressing interest-rate benchmarks for a sixth year, credit buyers are showing more concern that they'll miss out on a continued rally than get stuck with debt that lost 26 percent during the market seizure in 2008.

"For the past several years, people have been concerned about liquidity," said Eric Gross, a credit strategist at Barclays in New York. "Now we're hearing more about people seeking out illiquid bonds."

Fragile Market

Such debt tends to be more vulnerable to price swings when market sentiment deteriorates, because there are fewer buyers to bid on it when investor withdrawals force money managers to sell. Those risks intensified after stricter banking rules accelerated a pullback by Wall Street dealers that used their own money to facilitate trading.

Primary dealers that trade directly with the Fed cut their holdings of corporate bonds by 76 percent to $56 billion after peaking at $235 billion in 2007, Fed data through March show. After the central bank changed the way it reported the holdings in April, net speculative-grade bond holdings fell as much as 24 percent to a low of $5.63 billion in May before rising to $7.7 billion on Jan. 8.

Investors are demanding an average yield of 5.94 percent to own bonds sold at least 18 months ago in batches of less than $250 million, Barclays data show. That compares with an average 5.7 percent for newer debt offerings of at least $500 million. The gap, which averaged 0.5 percentage point last year and 0.92 percentage point in 2012, reached as much as 1.95 percentage points at the peak of the financial crisis in March 2009.

The yield on MGM Resort International's $238 million of 6.875 percent notes, which were issued in 2006 and mature in April 2016, has dropped 2.4 percentage points during the past year to 1.85 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. That compares with a decline of 0.5 percentage point to 5.4 percent on the casino owner's $1.25 billion offering of nine-year, 6.625 percent securities in December 2012.

"As people continue to look for yield and performance, they're willing to move into less-liquid areas of the market," said Shanahan, who manages high-yield credit investments for JPMorgan's $1.5 trillion asset management unit. "You're seeing a classic market cycle of people looking for pockets of value."

'Intoxicating Brew'

With corporate borrowers selling record volumes of debt to lock in all-time low yields amid global central bank stimulus, "there is a tremendous and potentially unsustainable amount of paper in investors' hands, and this harsh reality is causing much angst," according to a McKinsey & Co. and Greenwich Associates report in August.

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