Risk Flipped as CCCs Beat AAAs Most Since 2009: Credit MarketsMatt Robinson
Risk is being turned on its head in the corporate-bond market as debt deemed closest to default beats returns on the highest-rated debentures by the most in four years.
Securities ranked in the CCC tier or lower by Standard & Poor’s have gained 7.1 percent this year, compared with a 5 percent loss for AAA rated debt, according to Bank of America Merrill Lynch index data. AAAs are losing 1.2 percent this month, versus 0.5 percentage point for CCCs. The divergence is making this only the third year since at least 1996 in which the lowest-graded debt produced gains while top-rated bonds lost, the data show.
Investors are eschewing bonds with the most to lose when interest rates rise as the Federal Reserve signals it may soon begin pulling back from unprecedented stimulus. A measure of sensitivity to changes in benchmark rates is at about a record high for AAA bonds, while it is holding below the average over the past 10 years for CCC debt, the Bank of America Merrill Lynch index data show.
“It’s a perfect storm,” Stefan Lingmerth, a New York-based analyst with Phoenix Investment Adviser LLC, a distressed-debt investor, said in a telephone interview. “AAAs are more interest-rate sensitive, while CCCs are hardly affected,” and investors are looking for more yield as the economic recovery strengthens, he said.
Speculative-grade companies have issued $241.6 billion of the bonds in the U.S. this year, on pace to exceed the record $357.3 billion of sales last year, according to data compiled by Bloomberg. Debt from companies in the lowest ratings tier account for about a third of the $14.7 billion issued this month, up from 18 percent in July.
The bond market has been roiled ever since Fed Chairman Ben S. Bernanke outlined a plan in May that would start cutting the central bank’s $85 billion of bond purchases later this year if the world’s largest economy continues to improve.
Unsecured debt from Eden Prairie, Minnesota-based Supervalu Inc., which is rated Caa1 by Moody’s Investors Service, has gained 30.4 percent this year through Aug. 27, while bonds of Johnson & Johnson, the world’s largest maker of healthcare products, have declined 5.3 percent, Bank of America Merrill Lynch index data show.
The interest-rate sensitivity measure, known as effective duration, has climbed to 8 for all AAA rated debt and reached a record 8.2 reached last month, Bank of America Merrill Lynch index data show. The gauge, which is up from 5.7 at the end of 2008, compares with 3.8 for CCC graded bonds.
“Being long fixed-income duration” has worked for a lot of investors who are “now starting to rotate out of that,” Jon Duensing, head of corporate credit at Smith Breeden Associates, said in a telephone interview from Boulder, Colorado. “High-yield debt tends to have less interest-rate sensitivity.”
Elsewhere in credit markets, Verizon Communications Inc. is said to be seeking $60 billion in financing to back its potential purchase of Vodafone Group Plc’s stake in its wireless unit. Verizon bonds fell and the cost to protect against losses on its debt jumped to the highest level in three years.
Bonds of New York-based Verizon are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 4.4 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 company’s $1.75 billion of 2.45 percent notes due in November 2022 fell 0.8 cent to 87.8 cents on the dollar at 11:40 a.m. in New York, Trace data show. The yield rose to 4.06 percent from 3.94 percent.
Verizon is in discussions to acquire Vodafone’s 45 percent stake in Verizon Wireless for about $130 billion, according to people with knowledge of the matter. It’s working with several banks to raise $10 billion from each, or enough to finance about $60 billion of the buyout, said two of the people, asking not to be identified because the talks are private. The deal would be the largest in more than a decade.
“Given the risk of rising interest rates, it adds to the sense of urgency for Verizon to secure this asset that’s growing in value,” Brian Zinser, a New York-based credit strategist at Mizuho Securities Co, said in a telephone interview. “It’s becoming clear that there may be a limited window to be able to do a transaction of this size, which will likely require financing across both equity and debt capital markets.”
Credit-default swaps on Verizon, which typically increase as investor confidence deteriorates, rose as much as 29 basis points to 94.5 basis points, the highest intraday level since Sept. 1, 2010, according to data provider CMA, which is owned by McGraw Hill Financial Inc. and compiles prices quoted by dealers in the privately negotiated market. The contracts were quoted at 82 basis points as of 11:55 a.m. in New York, CMA prices show.
The Markit CDX North American Investment Grade Index, a credit-swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, fell for a second day, declining 1.3 basis points to a mid-price of 82 basis points, according to prices compiled by Bloomberg.
In London, the Markit iTraxx Europe Index, tied to 125 companies with investment-grade ratings, fell 1.7 to 104.8.
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.
The U.S. two-year interest-rate swap spread, a measure of debt-market stress, rose 0.7 basis point to 16.88 basis points, snapping a two-day decline. The gauge typically widens when investors seek the perceived safety of government securities and narrows when they favor assets such as corporate bonds.
Rising yields on benchmark Treasuries are putting the highest-rated corporate bonds on pace for their biggest losses since at least 1989, surpassing a 3.6 percent loss in 1999, according to Bank of America Merrill Lynch index data.
Yields on 10-year Treasuries have climbed 1.14 percentage points to 2.77 percent since reaching a 2013 low of 1.63 percent on May 2. The extra yield investors demand to own AAA rated bonds instead of similar-maturity Treasuries has climbed 6 basis points to 70 basis points, the index data show.
Moody’s is forecasting that default rates for speculative-grade companies globally will end 2013 at 3 percent before dropping to 2.5 percent in July 2014.
Yields on the lowest-rated debt, which have gained 196 percent since the end of 2008, have declined to 10.3 percent from 10.97 at the end of 2012 and as high as 41.3 percent in December 2008.
“There’s a lot of interest-rate risk, particularly in the very highest-rated bonds,” said Martin Fridson, the chief executive officer of New York-based FridsonVision LLC, a research firm that specializes in high-yield debt. “There isn’t much reason to believe that credit risk is escalating at present, whereas Treasury yields have certainly shot up very sharply since the beginning of the year.”
The importance of holding a AAA rating in the corporate-bond market has lessened as interest rates fell to unprecedented lows. The number of non-financial AAA companies in the U.S. has dwindled to four from more than 60 in the early 1980s, according to S&P.
“We may very well be at the end of a 30-year decline in rates,” Fridson said. “So it could be a painful period for a while to come.”