The market rout in stocks spilled into the corporate-debt markets Friday after investors began to more fully assess the harm that prolonged economic disruption from the coronavirus could do to highly indebted companies.
Reaction to the virus had been relatively muted in credit markets, where yields on even riskier junk bonds and loans had remained below levels seen during the selloff in late 2018. However, data on Thursday showed accelerating withdrawals from U.S. high-yield bond and loan funds in the past week, which was followed by a drop in European bank stocks driven by investors’ concerns over loan losses.
In Europe, the cost of protection on risky corporate credit jumped to its highest level in nearly four years on the leading IHS Markit index of riskier credit derivatives, the iTraxx Crossover. The cost rose to more than €388,000 ($436,000) annually to cover €10 million of bonds.
This followed a sharp rise in the U.S. CDX High Yield index, showing that it cost more than $409,000 annually to protect $10 million of bonds at the close on Thursday. The price of a BlackRock Inc. exchange-traded fund that often serves as a proxy for the high-yield market—known by its ticker symbol HYG—fell to about $84.68 from $86.02 Thursday.
While selling was broad-based, bonds of companies in sectors that could be most affected by the spread of the coronavirus, such as travel and energy, fell especially sharply. The yield investors demanded to hold short-term bonds of American Airlines Group Inc. jumped as high as 12.4% from 5% earlier in the week, with prices falling as low as 86 cents on the dollar from 92.75 cents Thursday, according to MarketAxess.
Amid a steep decline in oil prices, a Laredo Petroleum Inc. 9.5% bond due in 2025, which was issued at par in January, fell to 57.5 cents on the dollar from 69 cents Thursday.
Friday’s selling is notable because credit markets are critical to the functioning of the economy. Earlier this week, companies of varying credit quality were still issuing bonds, and the average yield of U.S. speculative-grade bonds remained below levels from last summer, according to Bloomberg Barclays data. But extended volatility could make it difficult for companies to borrow, exacerbating any economic hit from the coronavirus.
“Today was the day when it flipped from equity market leadership of the selloff to credit market leadership,” said Barnaby Martin, head of European credit strategy at Bank of America Merrill Lynch. “We were building up vulnerabilities…this is what happens when the market reaches for yield, which is hubris.”
The rush to buy protection and withdrawal from bonds was driven by dedicated credit funds being forced to cut back positions, amplified by a lack of liquidity in the markets, according to one senior credit trader in London.
This follows a wave of withdrawals from U.S. funds that invest in riskier credit, according to LCD, the loan research arm of S&P Global Market Intelligence. More than $5 billion was pulled from U.S. high-yield bond mutual funds and exchange-traded funds in the week to March 4, up from $4.2 billion the week before, according to Refinitiv Lipper. There had been net inflows, year to date, before last week.
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Funds that invest in risky loans, typically used to fund private-equity-backed companies, have also seen growing outflows, with $2.3 billion pulled in the week to March 4, bringing the total outflow over the past seven weeks to $4.7 billion, according to LCD.
After two weeks of equity market declines, corporate debt investors and analysts are growing more concerned about how economic disruption brought about by the coronavirus will hurt the cash flow and the credit quality of weaker companies, and particularly of smaller companies that typically have less capacity to bridge a drop on cash flows.
This is also one reason why bank stocks are getting hit, particularly in Europe, where there is already wide disruption to travel and one U.K. airline has been pushed into insolvency. The Euro Stoxx Banks index has dropped 7.5% in the past two days and is now down 24% since cases were reported in Italy in late February.
Shares of European banks, including Germany’s Commerzbank, have fallen sharply in recent days.
Photo: ronald wittek/ShutterstockSome analysts are now beginning to worry more about highly indebted businesses, and where exposures to them lie through the system of investment funds and structured products known collectively as the shadow banking sector.
“We are concerned that there are skeletons out there in closets we may not be aware of that come out in times like this, particularly leverage from the shadow banking system,” John Briggs, head of Americas strategy at NatWest Markets in New York, wrote in a Friday morning note. “I also worry about the small and medium sized businesses in particular.”
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—Matt Wirz and Sam Goldfarb contributed to this article.
Write to Paul J. Davies at paul.davies@wsj.com
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