Obama's Rebounding Economy Reflected in Junk Bond Market's Dividend Deals
Buyers of high-yield, high-risk debt are betting that President Barack Obama is leading the U.S. economy to an enduring recovery.
Investors have gobbled up $99.6 billion of junk-bond sales in 2010, a record for the first four months of the year, including the most bonds to fund dividends for private-equity firms since before the credit crisis began in August 2007, according to data compiled by Bloomberg and Standard & Poor’s LCD. Prices for the average speculative-grade security climbed to 99.7 cents on the dollar this week, the highest since June 2007, up from 54.8 cents in December 2008, according to the Bank of America Merrill Lynch U.S. High Yield Master II Index.
The return of an appetite for risk shows growing confidence that the U.S. will avoid a double-dip recession, said John Lonski, chief economist at Moody’s Capital Markets Group. Profits for companies in the Standard & Poor’s 500 Index surged 176 percent in the final three months of 2009, and the U.S. economy grew at a 3.2 percent annual pace in first quarter, after expanding 5.6 percent in the fourth quarter, the best back-to-back performance since the second half of 2003.
The junk-bond rally demonstrates “a sense that the worst is over for the U.S. economy and that a self-sustaining recovery could materialize by the summer,” Lonski said in an interview from his New York office. High-yield, or junk, bonds are those rated below Baa3 by Moody’s Investors Service and lower than BBB- by Standard & Poor’s.
The reopening in the high-yield market helps the neediest companies avoid bankruptcy because they can refinance their debt, said Daniel Janis, a money manager at MFC Global Investment Management in Boston. The high-yield default rate fell to 9.9 percent in the first quarter from 13 percent at the end of 2009, according to Moody’s. The measure will decline to 2.8 percent by year-end, the lowest in two years, Moody’s predicts.
The access to financing also helps spur economic growth because companies can fund business investments, Janis said. Forty-seven percent of corporate executives plan to spend more during the next six months, while only 7 percent plan to reduce expenditures, according to the Business Roundtable’s CEO Economic Outlook Survey released April 7. The balance anticipated no change.
“Now you have companies that have the ability to borrow,” said Janis, who oversees $4.2 billion in fixed-income assets. “As you refinance, then their business plans and capital- expenditures stuff gets funded. Before, they were shut out.”
The rally has given businesses on the brink of default, such as Harrah’s Entertainment Inc., access to capital and allowed leveraged-buyout firms to sell more debt to pay themselves dividends than at any point since before the credit markets seized up. High-yield companies controlled by private- equity groups have sold $3.1 billion of bonds so far this year to fund payouts, compared with $600 million in all of 2009, according to Standard & Poor’s LCD data.
Maxim Crane Works LP, based in Bridgeville, Pennsylvania, and owned by Platinum Equity Capital, sold $250 million of 12.25 percent notes on March 31 to finance a dividend. The debt is rated Caa1 by Moody’s and B by S&P.
“There is a bit of a feeding frenzy going on,” said Bruce Monrad, money manager at Northeast Investment Management Inc., who co-manages the $709 million Northeast Investors Trust high- yield fund in Boston. “A lot of the doomsday scenarios have abated.”
Las Vegas-based Harrah’s, the world’s biggest casino operator, averted a potential default in 2008 and 2009 by shaving $4.2 billion of debt when some creditors agreed to swap their holdings at a discount for new bonds.
This month, the casino company was able to sell $750 million of 12.75 percent notes due in 2018 that were rated Ca by Moody’s, two levels above default. Harrah’s was acquired by private equity firms Apollo Management LP and TPG in January 2008.
While investors have been rewarded with a record 68.7 percent return in junk bonds since 2008, the overall economic recovery hasn’t generated enough jobs or inflation to prompt the Federal Reserve to budge from near-zero interest rates. Unemployment has persisted above 9 percent since May 2009, and policy makers’ preferred inflation gauge, the personal consumption expenditures price index minus food and energy, declined to a 1.3 percent annual rate in February from 1.5 percent in January.
Economic conditions, including “subdued inflation trends and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period,” the Federal Open Market Committee in Washington said in an April 28 statement.
The Fed said it has seen some signs of life in the job market, which means the economy is strengthening. U.S. employers added 162,000 jobs in March, the third gain in five months and the most in three years.
Consumers in the U.S. also turned more optimistic this month. The Conference Board’s confidence index rose to 57.9, exceeding all forecasts of economists surveyed by Bloomberg News and the highest level since Lehman Brothers Holdings Inc. collapsed in September 2008, according to data from the New York-based private research group.
Corporate-bond buyers have been emboldened by company profits and the improvement in gross domestic product, according to Lonski of Moody’s. The fourth-quarter expansion was the most in six years.
The extra yield, or spread, investors demand to own speculative-grade securities instead of similar-maturity Treasuries shrank to 5.42 percentage points on April 26, the narrowest since June 17, 2008, and down from the record 13.2 percentage points in December 2008, Bank of America Merrill Lynch data show. The spread was 5.54 percentage points on April 29.
“It’s difficult to become especially concerned about credit when you have earnings growing at a rate that is a magnitude of the growth of debt,” Lonski said.
Profits at U.S. nonfinancial companies grew by 11.5 percent in the fourth quarter, compared with a 1.5 percent expansion by corporate debt in the same period, according to data compiled by Moody’s based on information from the Federal Reserve and Commerce Department.
Ford Motor Co., the only major U.S. automaker to avoid bankruptcy in 2009, reported first-quarter earnings of $2.1 billion this week, and Chief Executive Officer Alan Mulally forecast a “solid” 2010 profit. The Dearborn, Michigan-based company had a fourth straight quarter of net income, its longest streak since 2005.
Ford’s $1.8 billion of 7.45 percent bonds due in 2031 have climbed to 93.25 cents on the dollar from 15 cents in November 2008, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Ford, the second-largest U.S. car company, has benefited from a recovering auto market as Americans begin to spend more. Consumer purchases rose at a 3.6 percent annual rate in the first three months of this year, more than double the fourth- quarter pace of 1.6 percent and the most in three years.
“Some of the indicators have shown that things are a little bit better,” MFC Global’s Janis said. “The economy, I feel, is fine. I’m saying ‘We have no double dip.’”