UPDATE 2-U.S. junk bonds fall on subprime concerns

Fri Jul 20, 2007 1:30pm EDT

(Recasts lead, updates prices, adds background, byline)

By Dena Aubin

NEW YORK, July 20 (Reuters) - U.S. junk bonds sold off sharply on Friday, with some benchmark bonds collapsing to their lows for the year, as worries about the subprime mortgage crisis mounted, causing a broad repricing of risk.

"The market is in a really panicky state," said one trader. "It's essentially been 40 straight days of lower levels and a worsening environment."

The negative market sentiment pushed General Motors Corp.'s (GM.N) 8.375 percent bonds due 2033 down 1 cent to 88 cents on the dollar. Earlier, those bonds had traded as low as 87 cents on the dollar, a low for the year, according to MarketAxess.

GMAC's 8 percent bonds due in 2031 fell to 93.5 cents on the dollar on Friday, down 3 cents on the day, MarketAxess reported.

Bonds of a Harrah's Entertainment HET.N unit with a 5.625 percent coupon due in 2015 fell to 76 cents on the dollar on Friday, down from 78 cents on Wednesday, their previous significant trade, according to MarketAxess.

"Clearly there are technical pressures on leveraged assets as a result of what's happening in the mortgage market," said Kingman Penniman, president of high-yield research firm KDP Investment Advisors in Montpelier, Vermont. "There's so much damage there, and more damage that is at least feared."

Losses at two Bear Stearns hedge funds exposed to subprime mortgages have sparked worries about broader losses from the mortgage market, a junk bond trader said. Those fears escalated when Bear Stearns on Tuesday told investors that the two hedge funds have "very little value."

Worries about the impact of the housing market combined with disappointing earnings to push stocks sharply lower as well. The Dow Jones industrial average .DJI fell 173 points or 1.25 percent to 13,827.

Sentiment worsened on Thursday when the chief executive of homebuilder KB Home (KBH.N) said he does not expect the overall home market to bottom out until the end of next year. Federal Reserve Chairman Ben Bernanke said losses from the subprime mortgage fallout could reach $100 billion.

In the credit derivative market, the main index of U.S. high-yield credit default swaps widened by about 6 basis points to a record wide of 490 basis points.

"Whereas before the market was awash with liquidity, the market is now trying to find buyers," said KDP's Penniman.

Wall Street dealers, instead of providing liquidity by buying bonds, are "just watching prices go down," he said.

Some may be exacerbating the downward moves by shorting bonds to protect their proprietary trading positions or to hedge new deals they hope to bring to market, he said.

One corporate bond trader said he was not seeing massive amounts of selling, but buyers had evaporated.

"We're just seeing a repricing of the credit market," he said. "It's astounding. It's a complete reset."

A downturn in the junk bond market has all but dried up new bond sales, with just a handful of deals pricing all month. The selloff could further curb demand for all but top-tier issuers, hurting financing prospects for leveraged buyouts, market participants said.

"I think you would have a real hard time selling an LBO deal," said Robert Grimm, co-head of the high-yield group at J. Giordano Securities in Stamford, Connecticut.