Junk Bonds Supplant Loans as Returns Lure Cash: Credit Markets
Junk bonds are outperforming leveraged loans by the most since February, with inflows last week breaking four straight periods of redemptions, as the notes supplant bank debt in a refinancing wave.
The Bank of America Merrill Lynch U.S. High Yield Master II bond index has returned 5.4 percent this year through June 15 compared with a 3.9 percent gain in the Standard & Poor’s/LSTA Leveraged Loan 100 index. Cash investment in funds that buy speculative-grade bonds has boosted the size of the market by 40 percent since early 2009 while leveraged loans outstanding have contracted by 25 percent, JPMorgan Chase & Co. research shows.
Buyers are favoring junk bonds over loans as economists speculate the Federal Reserve may start a fourth round of economic stimulus with Europe’s sovereign-debt crisis escalating. Since 2009, about $199 billion of high-yield bond offerings have gone toward replacing loans, with maturities tied to leveraged buyouts cut by 60 percent, according to JPMorgan.
“Quality is about more than seniority; it’s about the composition of the companies in the market,” said Gershon Distenfeld, director of high-yield credit at AllianceBernstein LP, which oversees about $20 billion of speculative-grade debt. “High yield has had a really good run here.”
The 1.5 percentage-point gap between returns on high-yield bonds and leveraged loans has almost doubled from 0.8 percentage point at the end of March, according to data from Bank of America Merrill Lynch and S&P/LSTA. The difference was 1.6 percentage points as of Feb. 29.
Speculative-grade bond funds reported inflows of $838 million in the week ended June 13, compared with a $2.8 billion outflow in the prior period, bringing redemptions to $5.4 billion over the four weeks, according to Cambridge, Massachusetts-based EPFR Global. That compares with a $187 million outflow from leveraged loan funds last week.
Elsewhere in credit markets, the cost of protecting corporate bonds from default in the U.S. fell, with the Markit CDX North America Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, declining by 3 basis points to a mid-price of 116.2 basis points as of 12:36 p.m. in New York, according to prices compiled by Bloomberg.
That’s the lowest level on an intra-day basis since May 29 for the index, which typically falls as investor confidence improves and rises as it deteriorates. Credit-default 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.
The U.S. two-year interest-rate swap spread, a measure of bond market stress, fell 0.76 basis point to 25.18 basis points as of 12:35 p.m. in New York. The gauge narrows when investors favor assets such as corporate bonds and widens when they seek the perceived safety of government securities.
Bonds of General Electric Co. (GE) are the most actively traded dollar-denominated corporate securities by dealers today, with 77 trades of $1 million or more as of 12:36 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
The Fed’s outlook that benchmark interest rates will hold near zero until at least late 2014 is pushing investors toward riskier assets, causing yields on speculative-grade bonds to drop to as low as 7.47 percent on May 4 from this year’s high of 8.47 percent on Jan. 3, Bank of America Merrill Lynch index data show. Yields rose to 8.05 percent as of June 15.
Investors have funneled $17.6 billion into junk bond funds this year, 13 percent more than in all of last year, JPMorgan said in a June 15 report. That compares with leveraged-loan inflows of $1.7 billion, or 12 percent of the total for all of 2011.
“Money will continue to get pushed into this space,” said Jeffrey Hussey, the global chief investment officer of fixed income at Seattle-based Russell Investments. “There’s an interesting case in high-yield. That’s why we continue to see money pour in, sort of as an equities substitute.”
Junk-rated companies have defaulted at a pace below 3 percent for the past 16 months ended April 30, the longest such stretch since before the collapse of Lehman Brothers Holdings Inc. in September 2008 caused a credit seizure, S&P data show.
A Moody’s index measuring liquidity stress for the riskiest borrowers is holding at May’s record low of 3.3 percent.
“Liquidity levels remain healthy for U.S. speculative- grade corporations even as threats arise from around the globe,” according to a June 15 report by Moody’s analysts led by Tom Marshella.
“Given companies’ ongoing cautious approach to liquidity, a downturn would need to be severe and prolonged to use up the buffer provided by the current healthy liquidity position of high-yield corporates,” the analysts wrote.
Companies have sold $139.9 billion of high-yield debt this year following $243.9 billion of offerings in 2011 and a record $287.7 billion in 2010, Bloomberg data show. Leveraged-loan issuance has totaled $265 billion following last year’s $607.4 billion, according to the data.
About 65 percent of all junk bond and loan offerings from the past three years have been used to pay back existing debt, JPMorgan analysts led by Peter Acciavatti wrote in the June 15 report. The volume of leveraged buyout-related debentures maturing through 2015 has been reduced by $174 billion since the beginning of 2009, with 78 percent of that being pushed out to 2018 or later, they wrote.
Since the end of November, the Bank of America Merrill Lynch high-yield bond index has returned 8 percent through June 15, versus a 4.6 percent gain on the S&P/LSTA index. While the junk-bond market has expanded by about $378 billion since 2009, institutional loans outstanding have contracted by $194 billion, JPMorgan research shows.
“A year or two ago, people were afraid that rates were going to rise,” Distenfeld said. “People were throwing a lot of money at loan funds.”
After the recent returns for junk bonds, he said, “it’s understandable that investors may want to take some risk off the table. The way to do that is to buy a less-aggressive high-yield fund.”
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