Record Risk Discounted as Bonds Pass 110 Cents: Credit Markets
Corporate bond prices worldwide are poised to set a record as easy money policies by central banks push investors into riskier investments even with the potential for losses at about an all-time high.
Bondholders are paying an average of 110.22 cents on the dollar for the right to receive 100 cents back at maturity plus the interest from coupon payments, according to Bank of America Merrill Lynch’s Global Corporate & High Yield Index. At the same time, the so-called effective duration that measures how sensitive bond prices are to changes in yield has jumped, making the securities about the riskiest to hold ever.
Central bank purchases of government bonds to contain borrowing costs and stimulate economic growth have led investors to pour money into the $10 trillion global market for corporate bonds as they search for yield. Besides betting that interest rates won’t rise anytime soon, investors also face increased risk from restructurings. Cyprus and the Netherlands imposed losses on bondholders as part of their bank workouts, while a rise in leveraged buyouts globally threatens to trash credit ratings.
“We don’t like bonds with prices that move significantly above par, especially in financials,” said Chris Bowie, the London-based head of credit portfolio management at Ignis Asset Management Ltd., which oversees about $110 billion. “There’s interest-rate risk and on top of that, we’re in a world where we’ve seen depositor haircuts and bondholder expropriations when things go wrong, as well as the usual buyouts and mergers.”
For every 50-basis-point jump in yields, prices would drop an average 2.85 percent, compared with a low of 2.36 percent in September 2008, according to the average effective duration of the Bank of America Merrill Lynch index. Bond prices rose to a record 110.28 cents on the dollar in November. In 2009, the securities were trading below par.
Investors are paying about 152 cents on the dollar for Citigroup Inc.’s $2.5 billion of 8.125 percent debentures that mature in July 2039 and 137 pence for Goldman Sachs Group Inc.’s 500 million pounds ($764 million) of 7.25 percent securities due April 2028, the Bank of America Merrill Lynch index show.
Elsewhere in credit markets, Diageo Plc, the seller of Johnnie Walker Scotch and Crown Royal Canadian whisky, raised $3.25 billion in its first bond offering in almost a year. John Paulson, the hedge-fund manager trying to recover from more than two years of losses in some of his funds, told investors he likes convertible bonds. The Depository Trust & Clearing Corp. unveiled a product that will help participants in the syndicated-loan market accurately record the amount allocated to them in a deal.
The U.S. two-year interest-rate swap spread, a measure of debt market stress, fell for a second day, declining 0.41 basis point to 13.15 basis points, the lowest level since Jan. 16. The gauge narrows when investors favor assets such as corporate bonds and widens when they seek the perceived safety of government securities.
The cost of protecting corporate debt from default in the U.S. fell for a fourth day, with the Markit CDX North American Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, dropping 0.7 basis point to a mid-price of 80 basis points, according to prices compiled by Bloomberg. That’s the lowest level since March 15.
The Markit iTraxx Europe Index, tied to 125 companies with investment-grade ratings, rose 1.2 to 107 as of 10:35 a.m. in London. In the Asia-Pacific region, the Markit iTraxx Asia index of 40 investment-grade borrowers outside Japan was little changed at 111, according to data provider CMA.
The indexes typically fall as investor confidence improves and rise 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.
Bonds of JPMorgan Chase & Co. (JPM) were the most actively traded dollar-denominated corporate securities by dealers, accounting for 5.4 percent of the volume of dealer trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The largest U.S. bank by assets sold $2 billion of 10-year subordinated notes yesterday, according to data compiled by Bloomberg.
Diageo’s sale consisted of $750 million of three-year, 0.625 percent debt to yield 35 basis points more than similar- maturity Treasuries; $650 million of five-year, 1.125 percent notes at a relative yield of 55 basis points; $1.35 billion of 10-year, 2.625 percent securities at a 95 basis-point spread and $500 million of 30-year, 3.875 percent debt at 105, Bloomberg data show.
The world’s biggest distiller last sold debt in May, raising $2.5 billion in a three-part offering, including $1 billion of 2.875 percent, 10-year debentures to yield 107 basis points more than benchmarks.
Paulson, speaking on a conference call with clients, also said mortgage-backed securities have been performing well within the firm’s Credit Opportunities Fund, according to a person who listened and asked not to be identified because the information isn’t public. The strategy is Paulson’s biggest with $5.9 billion in assets, according to a letter obtained by Bloomberg News.
The S&P/LSTA U.S. Leveraged Loan 100 Index was little changed at 98.49 cents on the dollar. The measure, which tracks the 100 largest dollar-denominated first-lien leveraged loans, has gained 2.6 percent this year.
Leveraged loans and high-yield bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- at S&P.
The DTCC offering comes amid increased use of security identifiers through the use of CUSIPs and ISINs in the market for senior floating-rate debt, and participants are choosing electronic messaging over facsimile machines to save time as stock, bond and commodities exchanges have done for years.
“To create liquidity and transparency in the market, you need to have basic financial infrastructure in place,” Mathew Keshav Lewis, a London-based vice president for DTCC, said in a telephone interview. “There is still no central securities repository or a broadly adopted messaging format to standardize communication between agent and lender.”
Central banks from the U.S. to Europe and Japan have driven interest rates to record lows and experimented with bond purchases to push down long-term yields to revive their economies. U.S. five-year Treasuries yield about 0.70 percent, while yields on similar-maturity German debt, which were as low as 0.22 percent in July, are now at 0.34 percent.
The average yield on bonds in Bank of America Merrill Lynch’s broadest government bond index is about 1.34 percent, down from more than 4 percent in 2007. For corporate debt securities, the payout is about 3.17 percent, compared with 9 percent at the peak of the credit crisis following the failure of Lehman Brothers Holdings Inc. in late 2008.
There are now 13,347 bonds with a face value of $8.91 trillion included in the Bank of America Merrill Lynch Global Corporate & High Yield Index, up from 10,082 issues with a value of $6.21 trillion at the end of 2008.
“People are taking on interest-rate risk,” said Robert Smalley, a strategist at UBS AG in Stamford, Connecticut. “Money is still coming into fixed income, especially investment grade, but the expectation, at least until recently, is for rates to move up. In a market with low yields and tight spreads, a jump in interest rates will cause pain if you’re unhedged.”
Issuance of $1.3 trillion this year of corporate bonds follows an unprecedented $3.97 trillion in 2012, Bloomberg data show. Sales reached $3.94 trillion in 2009, the prior record, as companies rushed to issue with credit markets thawing.
The prospects for rising rates was dimmed earlier this month when the International Monetary Fund trimmed its 2013 global growth expectations for a fourth time. The Washington- based fund said April 16 it now estimates an expansion this year of 3.3 percent, down from a 3.5 percent forecast in January.
Defaults are low, and are forecast to stay that way, bolstering investor confidence that they will get their money back. The global default rate was 2.4 percent at the end of the first quarter, down from 2.8 percent in December, according to Moody’s Investors Service. The firm expects the rate to be 2.8 percent by year-end, it said in a report on April 8. Moody’s attributes the “remarkably steady” rate over the past 12 months to accommodative monetary policy and weak growth.
Bonds with the longest maturities are typically priced at the highest above par. Canada’s second-largest wireless carrier, BCE Inc. (BCE), has seen its C$150 million ($146.2 million) of 10 percent notes due December 2054 rise to 173 Canadian cents on the dollar, while Virginia Electric & Power Co.’s $700 million of 8.875 percent debentures maturing November 2038 are at 173 cents, according to the indexes.
Besides interest rates, corporate bond buyers must also contend with credit risk.
The Netherlands seized the subordinated bonds of SNS Reaal NV (SR), the country’s fourth-largest bank, after nationalizing the lender, whose soured real-estate loans threatened it with collapse. Cyprus wiped out bondholders of Cyprus Popular Bank Pcl and will force uninsured depositors to accept losses as it closes down the country’s second-largest lender in return for the nation’s 10 billion-euro ($13 Billion) bailout.
Those events have helped boost the appeal of non-financial corporate bonds, according to Barnaby Martin, a strategist at Bank of America in London.
“Cyprus was the game changer, it was a very scary policy,” he said. “If you try and target bank depositors in a resolution you’re going to get a reallocation out of banks and into assets such as high-grade credit.”
In North America, the value of mergers and acquisitions announced year to date is about $300 billion, a 26 percent increase from the $238 billion announced in the same period a year ago, Bloomberg data show.
Bonds of H.J. Heinz Co. plunged when Warren Buffett and his partners announced their $23 billion buyout in February. The company’s 6.75 percent securities due March 2032, which traded at 123.3 cents on Feb. 11, fell 19.3 cents to as low as 104 cents on Feb. 19 after the bid, Trace prices show.
While individual investors have pulled back from investment-grade debt, institutions are still a net 28 percent overweight, Bank of America’s Martin said, citing an investor survey published on March 15.
“Our survey is far from suggesting the days of reaching for yield in credit are over,” he said. “Quite the opposite.”
To contact the reporter on this story: John Glover in London at email@example.com