Yield, risk high with junk bonds

Let’s say you have a slightly seedy brother-in-law. He wants you to lend him $1,000, despite the fact that he doesn’t have a steady job and lives in a van down by the river. But things are going to get better, he says, and he’s promising to pay 25 percent on the loan. What do you say to him?

If you’re inclined to say “yes,” then there are about 100 junk-bond funds that would like to talk to you. But you should think long and hard before turning your cash into trash.

Junk bonds – the industry prefers the more genteel “high-yield bonds” – are long-term IOUs issued by companies with poor credit ratings. Like your deadbeat brother-in-law, these companies have to offer high interest rates to get lenders’ attention.

How high? Bond traders measure junk yields in comparison with ultrasafe Treasury yields. Junk-bond yields have averaged 4.92 percentage points more than comparable Treasury securities since 1981, says John Lonski, chief economist for Moody’s Investor Services.

Currently, the 10-year Treasury note yields 2.56 percent. In normal times, you’d expect a junk bond to yield about 7.5 percent.

These are not normal times, however. High-yield bonds now offer yields that once required your grandmother as security. The typical junk-bond now yields 19.9 percentage points more than Treasuries. Using the current 10-year T-note yield as our baseline, we’d expect an astonishing 21.74 percent yield from a typical junk bond.

The reason yields are so high, of course, is because traders are worried about default – in which case, bondholders would have to stand in line to get their principal back. An IOU, after all, is no better than the word of the company that issues it. And these days, Wall Street is taking no one’s word.

One reason managers are leery: When it costs 20 percent or more to borrow, precious few companies are willing to issue new junk bonds. “You’d have to be in some hyper-growth business,” says John Addeo, manager of MFS High Yield Opportunities. Hyper-growth businesses are hard to find these days.

So at the moment, there are very few new high-yield bonds coming to market. “It’s safe to say the market is broken,” Addeo says.