Bond markets are growing riskier as investors seeking steady returns bid up prices and ignore some early warning signs similar to those that flashed during the credit bubble, The WSJournal reports.  Just last week, prices on high-yield, or junk, bonds hit their highest level since 2007, nearly double their lows of the credit crisis.  Nine months into the year, companies have sold $172 billion in junk bonds - already an annual record - according to data provider Dealogic.

Reporters Carrick Mollencamp and Mark Gongloff note that, to some extent, the bull case for junk bonds is based on a declining rate of corporate defaults lately and a belief that, as long as the economy doesn't relapse into recession, default rates will continue to decline.  The financial crisis purged many weak borrowers from the system, and corporate balance sheets are generally stronger today than before the crisis.  However, a double-dip recession could hurt another, albeit smaller, wave of borrowers.

The demand for bonds has allowed some of the riskiest borrowers to sell bonds with fewer protections for investors. These provisions, or covenants, prevent companies from taking actions that would hurt bondholders and would protect investors if companies are sold.  According to Covenant Review, a "change-of-control" covenant typically offers bondholders the opportunity to sell back their bonds at 101% of par value when the company is sold.

• Some have watered down covenants, which are supposed to protect investors if a company is sold and prevent companies from loading on too much other debt or paying out their cash, which would cause a drop in value of the bonds or make it less likely the bonds they hold would get paid off.

• 57% of junk-bond issuers had less-stringent covenants than their previous junk deals;  41% of the deals had the same covenants;  just one deal had stronger covenants - stats based on 58 junk bonds issued in 2010 by companies that previously had issued debt.
  

• Tenet Healthcare's $600 million offering in August lacked an asset-sale covenant, which would have forced the company to use proceeds from the sale of a material asset to buy another asset, make capital expenditures or repay bond investors.  It also lacks a restricted payment covenant, which blocks dividend payouts.  [A Tenet spokesperson says the sale was privately placed to sophisticated investors.]

• Chesapeake Energy's (natural-gas producer) 2 bond offerings did not have a "change-of-control" covenant.  [A Chesapeake spokesperson says the sale was 3 times oversubscribed, while a spokesperson for lead underwriter Credit Suisse said the company is viewed by investors as high-quality.]

Demand for high-yield junk bonds boosts prices; investor protections decline.  Consider elevating your surveillance.

For a complete read, click on:  [ WSJournal's Bond Markets Get Riskier, 9/20 ]