Dealers absorbing junk bonds as ETF demand drops

Wall Street banks are expanding holdings of speculative-grade bonds as prices fall from record highs with investors retreating from exchange-traded funds that buy the debt.

The 21 primary dealers that do business with the Federal Reserve increased their net positions in junk-rated debt by 37% to $7.7 billion in the two weeks ended May 15, the highest since the central bank started reporting more detailed holdings data for the period ended April 3. U.S. high-yield funds reported $400 million of withdrawals last week, the second-most this year, led by $520 million pulled from ETFs, according to Bank of America Corp.

“ETFs tend to be the driver of big volume,” Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia, said in a telephone interview. The job of a dealer “is to buy bonds when people want to sell,” he said.

The dealers are soaking up supply as firms from JPMorgan Chase & Co. to Barclays Plc predict demand will return. Even with banks facing new limits on risk-taking and higher capital requirements since the credit crisis, the pullback from investors is prodding them to act in their traditional roles of facilitating trading with their own money as they underwrite an unprecedented volume of new speculative-grade debt.

Prices Drop

The average price for junk bonds in the U.S. has fallen 1.06 cents to 106.2 cents on the dollar after reaching a record 107.2 on May 9, Bank of America Merrill Lynch Index data show. Shares of the biggest high-yield ETF, BlackRock Inc.’s $15.8 billion iShares iBoxx High-Yield Corporate Bond Fund, declined 1.2% to $94.89 during the period as outstanding shares in the fund dropped 2.1%, data compiled by Bloomberg show.

Speculative-grade borrowers issued $17.2 billion of new debt in the week ended May 17, the most since March 22, as they sought to take advantage of a fifth year of benchmark interest rates held at about zero, according to data compiled by Bloomberg. Junk bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- at Standard & Poor’s.

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