Debt Traders Are Losing the Junk Retail Game

Issue 09-11-17   |   Reviewer:   Delvin D. Hawley, Ph.D.
Disciplines:


Abstract

Bond investors are playing a tricky game with lower-rated U.S. retailers, and they appear to be losing. The strategy is to buy the bonds of struggling retailers and collect the regular payments for as long as they can. If the companies remain solvent for longer than expected or improve their condition, the bond buyers win. Another way to win is if the company goes bankrupt but the debt was relatively high in the capital structure so the bondholders recover more of their investment. Bondholders lose if the borrowers' condition worsens, even if the slide extends over a long period of time. That's what's happening now for store owners such as Toys "R" Us Inc. and Bon-Ton Stores Inc., which both hired advisers this week to help them restructure their debt.

Toys "R" Us is one of the numerous retailers that were purchased by private equity firms and then loaded up with debt that they're now struggling to repay. On news that the company had hired a restructuring advisor, $208.3 million of bonds maturing in 2018 plunged to nearly 70 cents on the dollar from near par just days earlier. Bon-Ton has been losing money for years and reportedly just hired a firm to help it deal with its more than $900 million of debt. Prices on its bonds maturing in 2021 have fallen 25 percent this year.

Prices on high-yield bonds tied to U.S. retailers have dropped about 2.5 percent so far this year, with investors demanding yields as high as 9.9 percent on average earlier in 2017. The extra yield that investors are now requiring on U.S. retail junk bonds versus a broader index of the debt is at its highest point since the 2008-2009 financial crisis.

While some bond investors might get paid enough money in coupon payments to offset their losses during any restructuring, the chances of ending up on the winning side of this strategy are getting slimmer.





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