Capital Markets

Investors, Issuers Flee Junk-Bond Market

Speculative-grade bond funds suffer their fifth consecutive week of outflows.
Stephen TaubMay 17, 2004

The prospect of rising interest rates continues to wreak havoc in the speculative-grade bond market, even though this asset class traditionally benefits from an improving economy.

Investors pulled out $2.15 billion from U.S. junk bond mutual funds in the week ended last Wednesday, the second-biggest outflow ever and the most since last August, according to AMG Data Services.

This was the fifth consecutive week of outflows from junk-bond funds. The number of junk-bond funds seeing inflows fell from 148 a week earlier to 70, the fewest since 1994, according to Reuters, citing AMG data. The number of funds that suffered outflows surged from 207 to 286.

As a result, the new-issue market has all but dried up. Five companies — three of them rated single-B or lower — have pulled junk-bond sales in the last two weeks or so, and many more could follow.

“Investors want to be better compensated for the credit risk they are taking in lending to high-risk entities,” Fitch Ratings analyst Mariarosa Verde told Reuters. “The other factor at play is the fear that higher rates may cause the economy to slow down, which would magnify credit risk for low-rated borrowers.”

The most recent company to cancel its junk bond offering was Revlon Inc. On Thursday it said it would not complete a planned $400 million sale to refinance older, expensive debt due to “current unfavorable market conditions.”

In addition, Star Cruises Ltd., part of NCL Corp., canceled its plans to raise between $350 million and $450 million in junk bonds; auto-parts supplier Collins & Aikman Corp. scrapped its offering of $500 million.

Two other companies said they would set aside their deals and instead look to tap bank credit facilities. Credit-card issuer Metris Cos. Inc. entered into a new credit facility to provide for a three-year $300 million secured term loan with a group of institutional investors. And Regal Entertainment Group’s Regal Cinemas increased the size of its proposed senior secured credit facility from $1.35 billion to $1.75 billion..

The departure of investors combined with an overall sell-off in the market have pushed up junk bonds yields to 12.63 percent, the highest since December 2.

Investors are concerned not only about rising interest rates but also about Iraq, the upcoming presidential elections, and terrorism in general. Yet defaults are coming down and the economy is strengthening, the two factors that generally drive the junk market.