BL: Investors in junk bonds see slim chance of recovery
By Caroline Salas Bloomberg News Tuesday, March 25, 2008
NEW YORK: High-yield, high-risk bonds are off to their worst annual start ever, and the biggest investors say there is no recovery in sight.
Junk bonds have fallen 3.9 percent on average so far this year, losing about $35 billion, according to data from Merrill Lynch indexes. Some funds managed by John Hancock Advisers, OppenheimerFunds and Fidelity Investments are down more than 7 percent, showing that even the largest investors were caught off guard by the collapse.
Although the U.S. Federal Reserve has reduced benchmark interest rates by 3 percentage points since September, it has been unable to get investors to increase their purchases of the riskiest assets. The declines are choking off financing for speculative-grade companies, leading to increased defaults.
According to JPMorgan Securities, the debt is likely to "struggle" for months as the U.S. economy enters a recession.
"The moves have been absolutely vicious," said Arthur Calavritinos, whose $1.2 billion John Hancock High Yield Fund has lost about 9.8 percent since December. The Boston-based manager said it was the worst market since he began working in finance in 1985.
Just 11 companies have issued $9 billion of junk bonds in the United States in 2008, according to data compiled by Bloomberg. This time last year, 83 companies had sold $39.5 billion of them.
Junk bonds are those rated below Baa3 by Moody's Investors Service and lower than BBB- by Standard & Poor's.
The slump is hurting more companies than ever before.
About 51 percent of U.S. corporate borrowers are rated below investment grade, up from 28 percent in 1992, according to S&P. About $1 trillion of that debt is outstanding, compared with less than $10 billion 30 years ago.
The ratings of two of the world's biggest automakers, General Motors and Ford Motor, were cut to junk within the past three years, as was Clear Channel Communications, the largest U.S. radio broadcaster.
Investors are demanding yields averaging 8.07 percentage points more than U.S. Treasury bonds, up from a spread of 5.92 percentage points at the end of last year, and a record low of 2.41 percentage points in June, index data from Merrill Lynch show. The spread reached 8.62 percentage points on March 17, the biggest difference since 2003.
" 'Ouch' would be an understatement," said Stephen Antczak, a high-yield strategist at UBS in Stamford, Connecticut. In December, he predicted the debt would rally in January. Now, Antczak said he was "still bearish" and expected spreads to widen by 0.5 percentage point to 1 percentage point in the next quarter.
Peter Acciavatti, head of global high-yield strategy at JPMorgan in New York, predicted in a research note on March 14 that spreads would remain more than 8 percentage points "for some time, or at least until some remnant of an economic recovery is in sight." The biggest difference recorded by Merrill Lynch, whose index started in 1996, was 11.2 percentage points in October 2002.
Moody's said the default rate on junk bonds climbed to 1.3 percent last month from 0.9 percent in December, after Quebecor World, a printing company in Montreal, and Buffets Holdings, a restaurant chain based in Minnesota, filed for bankruptcy. The rating agency raised its forecast for the default rate this month to 5.4 percent from 4.6 percent by year-end.
Every industry group except energy and utilities has posted negative returns this year. Bonds of finance companies lost 20 percent; media bonds, 10.2 percent; and real estate securities, 9.9 percent, data from Merrill Lynch show.
"We've had no frame of reference for this kind of pervasive credit crisis," said Marilyn Cohen, president of Envision Capital Management in Los Angeles. "The problems are so huge, and they're everywhere."
Envision, which manages a $215 million fixed-income fund, is "certainly not" adding riskier investments, said Cohen, who has worked in the fixed-income market since 1979.
John Hancock, OppenheimerFunds and Fidelity, managers of three of the worst performing high-yield debt funds this year, also own bonds of R.H. Donnelley, the U.S. publisher of phone directories, regulatory filings show.
The company's bonds fell 24 percent in February, more than all but one other top-50 issuer in the high-yield market, according to Merrill Lynch.
"We're a highly levered company, which are very out of favor today," David Swanson, the publisher's chief executive, said during an interview this month. It would be difficult and expensive to sell debt, he said.
Calavritinos, at Hancock, said his fund was hurt mainly by its investment in airlines like Northwest Airlines, whose shares dropped as oil prices rose. Other holdings include Charter Communications, a cable company, and Trump Entertainment Resorts, a casino owner.
Bonds that trade at a spread of 10 percentage points or more over Treasury bonds are considered distressed because investors fear that the borrower will default. More than 180 companies have debt that is now considered distressed, Bloomberg data show.
The amount of distressed debt in one Merrill Lynch index tripled to $175 billion this year. It was only $4.4 billion in March 2007.
Mark Patterson, chairman and co-founder of MatlinPatterson Global Advisers, said the growth in junk bond yields was giving him an opportunity to make money. His firm invests in bankrupt and distressed companies.
"This is going to be, in history, a great buying time at low values," Patterson said.
The $3.4 billion Fidelity Advisor High Income Advantage Fund, which invests in high-yield bonds, preferred shares and convertible securities rated below investment grade, lost 7.52 percent this year. The $2.1 billion Oppenheimer Champion Income Fund, which mainly buys high-yield debt, has tumbled 13.1 percent.
Alexi Maravel, a spokesman for Fidelity, said shareholders expected the company to "invest for the long term," and "focusing on the year-to-date is a very, very short period of time." Jeaneen Pisarra, a spokeswoman at Oppenheimer, declined to comment.
The $188 million Morgan Stanley High Yield Securities Fund is the best-performing fund in the sector this year, having lost 0.01 percent, according to Morningstar
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