Junk Credit Conditions Imperiled by Rate Rise, Moody’s Says

Redemptions from junk-bond funds, spurred by Treasury yields at about the highest level in almost two years, threaten to derail stable credit conditions for the riskiest U.S. companies, according to Moody’s Investors Service.

The credit grader’s list of companies rated B3 with a “negative” outlook and lower rose to 160 on June 1 from a post-recession low of 146 three months earlier, a Moody’s report shows. U.S. 10-year Treasury yields climbed to 2.61 percent yesterday, the highest close since August 2011, amid speculation the Federal Reserve will trim its $85 billion monthly bond-buying program this year. The yields fell to 2.57 percent at 1:03 p.m. today in New York.

Rising yields and fund redemptions may drain the market liquidity that has bolstered corporate balance sheets and lowered default risk, according to Moody’s analysts led by David Keisman. U.S. junk-rated debt has lost 3.71 percent in June through yesterday, poised for its worst monthly decline since November 2008, Bank of America Merrill Lynch data show.

“What was great about the Fed injecting those trillions of dollars was that corporations took advantage of it to lower coupons and push out maturities,” Keisman, who is based in New York, said in a telephone interview. “If liquidity goes away, when it comes time for refunding, they won’t be able to, and that will drive a default cycle.”

Liquidity Stress

U.S. high-yield bond funds have lost 3 percent of their assets through net outflows this year, according to a June 20 research note from Bank of America Merrill Lynch. Dollar-denominated offerings of speculative-grade bonds reached $2.4 billion in the week ended June 21, compared with the 2013 weekly average of $8.2 billion, Bloomberg data show.

Investors are ignoring a credit backdrop still showing that few U.S. speculative-grade companies face liquidity problems or risk violating debt covenants, Keisman said. Moody’s list of the riskiest junk-rated companies is still 45 percent smaller than its peak of 289 reached during the second quarter of 2009.

The credit-grader’s liquidity-stress index, which rises as companies find financing more difficult to obtain and falls as their ability to manage cash needs improves, reached 3.3 percent as of the middle of June, below the 7.3 percent average since 2002, Moody’s data show. The U.S. speculative-grade default rate will reach 2.4 percent by year-end, down from 2.9 percent in May, according to the report.

“The fundamentals are maybe ticking up slightly, but they’re mostly just staying the same,” Keisman said. “And whenever the market moves in one direction and the fundamentals stay in the other, that’s when things get interesting.”

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