Junk Yields Outweigh Default Risk, Wells Capital’s Patel Says

Investors may still find value in speculative-grade corporate bonds paying record-low yields as a falling default rate curbs the risk of losses, according to Margie Patel, a money manager at Wells Capital Management Inc.

“The economic growth looks like it’s stable to accelerating, there’s no sign defaults are going to pick up and the composition of the high-yield market to me looks pretty good,” Boston-based Patel, who oversees about $1.5 billion at the unit of Wells Fargo & Co., said today in an interview on Bloomberg Radio’s “Surveillance” with Tom Keene and Michael McKee.

Corporate borrowers have sold $183.4 billion of dollar-denominated, speculative-grade bonds this year, the most for the period on record, according to data compiled by Bloomberg, as unprecedented stimulus efforts by the Federal Reserve suppress interest rates and push investors into riskier assets to boost yields.

As yields in a Bank of America Merrill Lynch junk-bond index fell to a record low of 5.98 percent on May 9, about 80 percent of issuers in the first quarter that disclosed use of proceeds were borrowing to refinance debt, according to Moody’s Capital Markets Research Group data. That’s poised to keep default rates low, Patel said.

“The pool of candidates likely to go into default a couple years from now look pretty small based on the issues that have come to market in the last couple of years, especially when it looks as if the economy is moving ahead,” she said. “That’s a pretty good backdrop, and the Fed is clearly not going to be slamming on the brakes.”

Default Rate

The speculative-grade default rate in the U.S. is projected to fall to 2.7 percent this year, the lowest level since February 2012, according to Moody’s Investors Service.

The extra yield investors demand to own junk bonds instead of Treasuries with similar maturities, which reached a more than five-year low of 423 basis points this month, is still higher than the 2006 average of 326 basis points, Bank of America Merrill Lynch index data show. With a muted default rate, “we actually could narrow spreads because high yield doesn’t have a lot of risk right now,” Patel said.

JPMorgan Chase & Co. and Barclays Plc lifted their forecasts for U.S. junk-bond returns as this year’s rally exceeds the expectations of top-rated credit strategists.

Barclays analysts predict high-yield bonds may gain 8 percent in 2013, as much as four percentage points more than their original expectation, strategists led by Jeffrey Meli and Bradley Rogoff said in a May 17 report. JPMorgan sees “modest upside risk to our original full-year return forecast of 7 to 8 percent for U.S. high yield” and now expects gains of as much as 10 percent, according to strategists led by Jan Loeys.

High-yield, high-risk bonds are graded below Baa3 by Moody’s and lower than BBB- at Standard & Poor’s.

“There’s a lot of issues to choose from in a wide range of industries, and they’re priced more or less appropriately for the risk,” Patel said. “So that’s not a bad market.”

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