Watch for Junk-Bond Air Pockets as Sprint Spirals Downward

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Sprint Corp. is a cautionary tale for investors who think they’re immune to carnage in the $1.3 trillion junk-bond market as long as they steer clear of energy debt.

Moody’s Investors Service on Tuesday downgraded the wireless company, which has more than $30 billion of debt outstanding, as it struggles to compete with better capitalized competitors such as AT&T Inc. and T-Mobile USA. Much of the company’s debt was downgraded several steps to Caa1, which is considered close to default.

The market response was fierce. Sprint’s $2.5 billion of bonds maturing in 2028 plunged as low as 80.8 cents on the dollar from 88.4 cents on Monday. Its $4.2 billion of notes maturing in 2023 fell as low as 90.1 cents from 98.6 cents two days earlier.

Many big high-yield bond-fund managers, including Pacific Investment Management Co., Franklin Advisors Inc. and BlackRock Inc., hold Sprint debt. It’s one of the most frequently traded names in the junk-bond universe. The company’s challenges are no surprise, of course. It’s why it has a speculative-grade rating in the first place.

But some investors were clearly caught off guard by Moody’s action, which put some of the company’s bonds in the lowest-ranked bucket. Some funds have a limit on how much of the junkiest junk they’ll hold, and they will sell if too much of their holdings are downgraded to that level.

This just shows that even the most highly traded, popular names can be vulnerable to sudden plunges that leave millions of dollars of losses in their wake.

Sprint is hardly the last one to experience such an air pocket in its value. On Tuesday, the company’s unfortunate plight apparently dragged down debt of Frontier Communications Corp., with investors reducing their exposure generally to telecommunications-related debt.

Debt of energy, coal and metals companies have been the hardest hit in the past year in tandem with falling commodity prices. Investors have largely responded by simply steering clear of those particular companies and piling into high-yield debt that’s less exposed to falling crude and steel values.

But that clock is running out on that model. Companies in other industries, such as retail, are also running into trouble, and that will only become more common as this credit cycle ages.

While the high-yield bond market may not face a sudden, widespread collapse that some investors have predicted, specific companies will most likely run into trouble as they fail to increase revenues enough to justify their debt load.

And some of those will be big names popular with debt investors who thought they had a safety net.

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