Junk-Bond Well Runs Dry as Oil Shock Quells Debt Supply

The market for new junk bonds has all but shut as plunging oil prices and borrowing costs at an 18-month high deter issuers.

Even as sales of high-yield, high-risk notes in the U.S. reached a record $353.1 billion this year, offerings have stalled this month with the slowest pace for a December since 2011. Junk is on track to deliver its second straight quarterly loss, the first time that’s happened since 2008, and trimming gains for the year to 1.47 percent, according to Bank of America Merrill Lynch index data.

Issuers see little reason to test investor appetite as markets get whipsawed by a tumble in commodity prices led by oil falling below $60 a barrel for the first time since 2009 and a slowdown in global economic growth. The pain is being felt most by energy companies, which make up 17 percent of the high-yield bond market.

“Momentum in high-yield is coming to a halt,” Margie Patel, a money manager who oversees $1.4 billion for Wells Capital Management in Boston, said in a telephone interview. “We are still seeing the results of oversupply, most of which comes from the sector that has been disproportionately impacted by big changes in energy prices, along with global growth worries that have caught the market wrong-footed.”

Yields Climb

After six years of easy monetary policies by the Federal Reserve boosted the ability of the least-creditworthy companies to borrow on favorable terms, investors are becoming more discriminating.

The average yield on speculative-grade debt climbed to 7.11 percent yesterday from an all-time low of 5.69 percent in June, Bank of America Merrill Lynch data show. The securities lost 2.47 percent in December, which would be the worst monthly performance since June 2013, underperforming both the 0.06 percent return in the U.S. Treasury market and the 0.41 percent loss from investment-grade bonds.

Investors pulled $1.89 billion from U.S. high-yield bond funds in the past week, the largest withdrawal since the period ended Oct. 1, and more than double the $859 million taken out the previous period, according to Lipper, the data provider owned by Thomson Reuters Corp.

“As retail investors see the negative performance, that may contribute to more outflows in the weeks ahead,” Michael Sohr, a money manager at AllianceBernstein Holding LP, which oversees more than $30 billion of high-yield debt, said in a telephone interview.

Junk Pipeline

Kindred Healthcare Inc., the operator of hospitals and nursing centers, dropped a planned 10-year portion from a $1.35 billion bond transaction earlier this week, making the terms more attractive for investors. Englewood, Colorado-based Westmoreland Coal Co. boosted the yield on a $700 million offering of bonds this week to 9 percent from the 8.75 percent it marketed to investors earlier.

Global Cash Access Holdings Inc. is planning to issue $700 million of notes in two parts as soon as next week and Signature Group Holdings Inc. is seeking to raise $300 million of five-year debentures.

Investors withdrew $1.05 billion from U.S. loan funds in an unprecedented 22nd straight week of outflows, according to Lipper. The exit increased net outflows for the year to $17.6 billion. Loans have lost 1.5 percent this month, reducing gains for the year to 0.89 percent, according to the Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index.

Growth Forecast

Juicy yields and inflation that has failed to reach the Fed’s 2 percent target for 30 straight months may entice investors back into the junk market. The U.S. consumer price index has risen an average 1.62 percent over the past five years, the least since the five-year period ended in 1965.

“Yields are still low with low prospects of them ratcheting higher with inflation in check,” James Sarni, a senior managing partner at investment manager Payden & Rygel, said in a telephone interview. “Once the panic wears off it becomes clear that high yield is one of the few places where you can still earn something with your money.”

The European Central Bank last week unveiled “substantially” lower forecasts for inflation and growth in the euro region, warning of a deflationary spiral, adding to investor trepidation over riskier securities.

The weakness in junk bonds coincides with a drop in West Texas Intermediate crude to $59.37 a barrel as domestic output increases to the highest level in more than three decades.

Continued instability in energy markets may exacerbate the selling in high-yield markets, according to Jack Flaherty, an investment manager at New York-based GAM USA Inc., which manages $17 billion.

“When do you say ‘this is enough?’ I don’t think anybody is doing that this year,” Flaherty said in a telephone interview. “It’s going to carry on for a while.”