Duration Risk at Record as Companies Boost Long-Term Debt: Credit Markets
Investors Vulnerable to Loss on Rising Duration
Alessandra Benedetti/Bloomberg
A 50 basis-point increase in the yield of Telecom Italia SpA’s 5.25 percent notes due 2055, for example, would cost 6 euros for every 100 euros ($129) invested at current values.
A 50 basis-point increase in the yield of Telecom Italia SpA’s 5.25 percent notes due 2055, for example, would cost 6 euros for every 100 euros ($129) invested at current values. Photographer: Alessandra Benedetti/Bloomberg
Corporate bond investors are facing the potential for record losses when policy makers start to raise interest rates as companies take advantage of falling borrowing costs to sell longer-term debt.
Bondholders are more vulnerable because notes maturing in 10 years or more made up 39 percent of sales last month, the most since December 2007, according to data compiled by Bloomberg. Bank of America Merrill Lynch indexes show the duration of corporate debt measuring price sensitivity to yield changes climbed to a record 5.69 years on Aug. 31. Telecom Italia SpA’s 5.25 percent notes due 2055 would lose 6 percent of face value should the yield rise 50 basis points.
“By buying longer-dated bonds, investors are making the assumption that interest rates will stay extremely low,” said Mehernosh Engineer, a strategist at BNP Paribas SA in London.
While a majority of futures traders are betting the Federal Reserve will keep the target interest rate for overnight loans between banks at a record low zero to 0.25 percent for the next year, analysts are starting to project the costs to investors for an eventual tightening of credit. Investors who could get a yield of more than 4 percent on five-year company debt in the first quarter of 2009 now have to buy 15-year bonds for a similar return, according to an analysis by BNP Paribas.
Elsewhere in credit markets, the extra yield investors demand to own company debt instead of similar-maturity government bonds fell 1 basis point to 178 basis points, or 1.78 percentage point, Bank of America Merrill Lynch’s Global Broad Market Corporate Index shows. Yields averaged 3.585 percent, down from 3.595 percent on Sept. 3.
Burlington Northern Offering
Burlington Northern Santa Fe, which was acquired this year by Warren Buffett’s Berkshire Hathaway Inc., boosted the size of its second bond offering in 2010 to $750 million. The company may sell $250 million of 10-year notes and $500 million of 30.5- year debt as soon as today, a person familiar with the transaction said. Proceeds may be used for working capital, capital expenditures and to repay outstanding debt, the railroad said in a regulatory filing that didn’t specify the sale’s size, maturity or timing.
The cost of protecting corporate bonds in the U.S. from default rose after falling for four straight days. The Markit CDX North America Investment Grade Index Series 14 climbed 2.8 basis points, the most in two weeks, to a mid-price of 106.55 basis points as of 12:39 p.m. in New York, according to Markit Group Ltd.
The index, which reached a four-week low on Sept. 3, typically rises as investor confidence deteriorates and falls as it improves.
Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
Longer-Term Debt
Tumbling interest costs have encouraged companies to sell longer-dated bonds. The average yield on Bank of America Merrill Lynch’s Global Broad Market Corporate index fell to a record 3.44 percent on Aug. 24.
Two-year U.S. Treasury yields slipped to an all-time low 0.45 percent on Aug. 24, before rebounding to 0.49 percent. The yield on Germany’s 10-year bund, Europe’s benchmark, dropped to 2.09 percent on Aug. 31, the lowest ever, and was at 2.25 percent today.
Companies around the world issued $81.1 billion of debt due in at least 10 years last month, according to data compiled by Bloomberg.
100-Year Bond
U.S. railroad operator Norfolk Southern Corp. sold $250 million of 100-year bonds on Aug. 24 in the first corporate securities of that maturity since 2005. The Norfolk, Virginia- based company priced its reopening of an existing issue to yield 5.95 percent.
San Diego Gas & Electric Co., a California utility rated A by Standard & Poor’s, sold $500 million of 30-year 4.5 percent securities on Aug. 23, according to Bloomberg data. That matches the interest rate paid by AAA rated drugmaker Johnson & Johnson on Aug. 12, the lowest coupon on record for debt of that maturity.
“Investors are reaching for duration, which means portfolio valuations that are more volatile” as the economy improves, said Zoso Davies, a credit strategist at Barclays Capital in London.
Companies in the U.S. added more jobs than forecast in August, according to a government report last week, easing concern the world’s largest economy is sliding back into a recession and raising the prospect of eventual interest-rate increases. Private payrolls climbed 67,000 last month, the Labor Department in Washington said on Sept. 3.
Fed Rate
The Federal Reserve has kept its target overnight lending rate between banks at a record-low zero to 0.25 percent since December 2008 as it seeks to stoke economic growth. The European Central Bank’s main refinancing rate has been at an all-time low of 1 percent since May 2009.
Companies, particularly banks, have also been encouraged to sell longer-term bonds since 10-year interest-rate swaps fell below Treasury yields for the first time this year, the Bank for International Settlements said yesterday in its latest quarterly review.
The 10-year swap rate first dropped below yields on similar-maturity U.S. government debt in March, and was 3 basis points lower at 2.62 percent today, Bloomberg data show. A negative swap spread makes it cheaper for borrowers to hedge their liabilities by exchanging floating- for fixed-rate payments.
“The negative 10-year swap spread may reflect hedging related to U.S. corporate bond issuance,” Basel, Switzerland- based economists Jacob Gyntelberg and Michael R. King wrote in the report. “Banks in particular may have been quick to take advantage of this opportunity.”
To contact the reporter on this story: John Glover in London at johnglover@bloomberg.net
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