Junk Bonds Grow More Popular and Turn Even Riskier

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The New York Times
Monday, October 29, 2012

Junk Bonds Grow More Popular and Turn Even Riskier

By NATHANIEL POPPER

Junk bonds are living up to their name again.

Companies with junk credit ratings have been increasingly issuing bonds for riskier purposes that could hinder their ability to pay back bondholders.

Demand for junk bonds has touched record levels this year as investors reach for their rich yields, a stark contrast to the meager returns available on Treasury securities and money market accounts. But the voracious demand has allowed companies to easily raise money for things that may actually end up weakening them.

For most of this year, the bond issuers were at the higher end of the junk credit-rating spectrum, and were using the money to refinance old debt at lower interest rates, thereby solidifying their economic footing. That made many analysts feel more comfortable about the flood of new junk bonds.

But in recent weeks, there has been a decline in the average credit rating of the companies issuing junk bonds, to C ratings nearer the bottom of the junk rankings from the BB ratings at the top. And companies have been using more of the proceeds for the sorts of risky projects that were common before the financial crisis and in the go-go days of the 1980s — paying dividends to private equity owners and financing mergers and leveraged buyouts.

Jo-Ann Stores and Petco, for instance, both with junk ratings of CCC, sold a combined $875 million of bonds this month, with some of the money set to quickly leave the companies through dividend payments to their private equity owners. Many analysts say that the practice can hurt the financial health of the companies by increasing their regular interest payments to bondholders without strengthening the underlying business.

“Companies that were having difficulty coming to the market, or who want to be more aggressive, have now gotten the opportunity to do so,” said Kingman Penniman, the founder of a junk bond research firm. “Clearly it’s a disturbing trend.”

The shift is particularly worrying to Mr. Penniman and others because so much of the money going into these bonds is coming from individual investors who may be unaware of the declining credit quality.

Over the first three quarters of the year, retail and institutional investors piled into junk bonds with equal alacrity. The record for junk bonds issued in the United States in a single year was broken on Oct. 18, and now stands at $293 billion, compared with $249 billion in all of 2011, according to Dealogic. But in recent weeks, as the bonds have grown risker, figures from the data company EPFR show that wiser institutional investors have begun to shift money out of junk bonds, as individual investors have continued to pour in. Retail investors added about $2.1 billion to their portfolios in the first three weeks of October, compared with a net outflow of $256 million from institutional investors.

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