Sales of
corporate bonds in the U.S. are surging toward the busiest May ever as borrowers race to the market before demand dries up with Bill Gross and Warren Buffett cautioning against buying debt at all-time low yields.
Warren Buffett earlier this week joined a long list of high-profile investors warning about the perils of the asset class in an era of rock-bottom
interest rates when he said bonds are a “terrible” investment. Indeed, the threat of higher inflation and rising
interest rates on future bond returns has been a constant on markets for several years now. But unlike Mr. Buffett and others who suggest bonds be avoided at all costs, many investors are choosing to tackle the risks that lie ahead not through total liquidation, but by adjusting their bond mix to provide more exposure to shorter-term maturities and greater diversification.
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Petroleo Brasileiro SA’s US$11-billion deal, the biggest on record for an emerging markets issuer, leads sales this month of US$120.2 billion, on pace to exceed the unprecedented US$162.6 billion sold in May 2008, data compiled by Bloomberg show. Issuance has already eclipsed the US$108.2 billion sold in all of May 2012.
Borrowers are accelerating sales as speculation mounts that yields may only rise amid signs the economy is improving. Three Federal Reserve regional bank presidents called last week for phasing out the central bank’s monthly purchases of US$40 billion in mortgage-backed securities as the housing recovery shows signs of gaining momentum, potentially reducing demand for riskier assets from stocks to speculative-grade bonds.
“Many issuers may decide it is not worth tempting that fate,” Edward Marrinan, a macro credit strategist at RBS Securities in Stamford, Connecticut, said in a telephone interview. The firm is one of the 21 primary dealers of U.S. government securities authorized to trade with the Fed.
Tempting Fate
Buffett, the billionaire chairman and chief executive officer of Omaha, Nebraska-based Berkshire Hathaway Inc., told Bloomberg Television this month that he felt “sorry” for fixed-income investors with yields on corporate bonds so low.
Yields fell to an unprecedented 3.35% on May 2 from more than 11% in 2008, according to the Bank of America Merrill Lynch U.S. Corporate & High Yield index. That represents
interest savings of about $76.5 million a year on every $1 billion borrowed. Yields ended last week at 3.465%.
Gross, manager of the $293 billion Total Return Fund for Newport Beach, California-based Pacific
Investment Management Co., said in a Twitter post on May 10 that a three-decade bull market in bonds probably ended April 29. Investors chasing yield have led to “frothiness” in some markets, analysts at Morgan Stanley led by Adam Richmond in New York wrote in a May 17 report.
“Investors have cash to spend yet fewer alternatives to buy,” the Morgan Stanley analysts wrote. Purchasers are having to accumulate corporate bonds “at levels sometimes not justified by fundamentals,” they wrote.
Spreads, Swaps
Elsewhere in credit markets, the extra yield investors demand to hold corporate bonds globally rather than government debentures held at the lowest level in more than five years. The cost of protecting corporate bonds from default in the U.S. and Europe declined. Prices on leveraged
loans fell.
Spreads on
company bonds from the U.S. to Europe and Asia were little changed at 134 basis points, or 1.34 percentage points, after reaching that level on May 10, the least since Nov. 12, 2007, according to Bank of America Merrill Lynch’s Global Corporate index. Yields fell to 2.518% from 2.521% a week earlier.
The Barclays Global Aggregate Corporate Index has lost 1.71% this month, bringing the loss for this year to 0.51%.
The Markit CDX North American Investment Grade Index, used to hedge against losses or to speculate on creditworthiness, fell 1.9 basis points last week to 70.3 basis points, according to prices compiled by Bloomberg. The index reached 68.9 on May 7, the least since Nov. 6, 2007.
Petrobras Active
The Markit iTraxx Europe Index of 125 companies with investment-grade ratings decreased 2.7 to 88.5, the lowest since May 2010, at 9:15 a.m. in London.
Both 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 swap protecting $10 million of debt.
The Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index fell 0.03 cent to 98.85 cents on the dollar. The measure, which tracks the 100 largest dollar-denominated first-lien leveraged loans, has declined from 98.88 on May 9, the highest since July 18, 2007.
Leveraged loans and high-yield, high-risk, or junk, bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- at S&P.
Global Sales
In emerging markets, relative yields widened 1.4 basis points to 276.6 basis points, according to JPMorgan Chase & Co.’s EMBI Global index. The measure ended last year at 265.8.
Bonds of Rio de Janeiro-based Petrobras were the most actively traded dollar-denominated corporate securities by dealers last week, accounting for 5.2% of the volume of trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
The company’s $3.5 billion of 4.375%, 10-year notes rose 1.6 cents from their issue price on May 13 to 100.42 cents on the dollar to yield 4.32%.
Corporate bond offerings in the U.S. have exceeded the $29.5 billion weekly average for the past 12 months in each of the past five weeks, propelling sales to the busiest pace ever.
Issuance has reached $689.6 billion this year, exceeding the $593.2 billion in the corresponding period of 2012. Globally, offerings total $1.66 trillion, the fastest pace behind $1.8 trillion in the similar timeframe in 2009.
‘Substantial Appetite’
“Investors worldwide still have a substantial appetite to own high-quality, fixed-income assets,” RBS’s Marrinan said. “The crowding-out effect of central bank purchases of government securities is forcing the investors into a diminishing pool of buyable high-quality corporate exposure.”
Petrobras split its offering in six parts, including fixed- rate bonds due in three, five, 10 and 30 years as well as three- and five-year floating-rate bonds, Bloomberg data show.
Apple Inc. sold $17 billion of bonds in the biggest corporate offering on record on April 30 as the iPhone maker issued its first debentures since 1996, Bloomberg data show. The sale included $4 billion of 1%, five-year notes paying a relative yield of 40 basis points and $5.5 billion of 2.4%, 10-year securities with a 75 basis-point spread.
Proceeds from the Apple offering will help finance a $100 billion capital reward for shareholders. The sale was a “great example of companies using funds for equity-friendly behavior,” John Lonski, chief economist for Moody’s Capital Markets Research Group in New York, said in a telephone interview.
‘Not Buying’
Buffett said he isn’t investing in corporate debt, including Apple’s record offering, because yields are too low.
“We’re not buying corporate bonds of any kind now,” Buffett, 82, said May 4 during an interview with Bloomberg TV’s Betty Liu in Omaha, where Berkshire held its annual meeting. “Not at those yields.”
Gross, known as “The Bond King” in media outlets and named fixed-income manager of the decade in January 2010 by Morningstar Inc., said May 10 that returns will probably be in the range of 2% to 3%.
Markets are entering “a 12-month period of time ahead in which, combined, Treasury, corporate and high yields don’t move much,” Gross, the co-founder and co-chief investment officer of Pimco, said in a May 16 Bloomberg Television interview with Erik Schatzker and Sara Eisen.
“Given this juncture where we are, there are a lot of different opinions and the range is pretty wide,” Dorian Garay, a New York-based money manager for an investment-grade debt fund at ING Investment Management, said in a telephone interview. “Uncertainty is pretty high.”
Benchmark Maintained
The Federal Open Market Committee said May 1 it will keep up its monthly purchases of mortgage bonds and $45 billion in Treasuries, and is ready to increase or reduce the pace in response to changes in the outlook for inflation and the labor market.
Dallas Federal Reserve Bank President Richard Fisher said May 16 that buying mortgage bonds risks disrupting the market, while Philadelphia Fed President Charles Plosser said, “it’s not good for the bank to be holding lots of mortgage paper.” Jeffrey Lacker of Richmond said to reporters a day earlier that the Fed should “get out of the credit allocation business.”
Policy makers also are maintaining benchmark interest rates, kept in a range between zero and 0.25% since December 2008, at record lows as long as the outlook for inflation doesn’t exceed 2.5% and unemployment remains above 6.5%.
Issuance ‘Wildcard’
“The wildcard for issuance will likely be what rates do during the remainder of the year,” analysts led by Jason Shoup at Citigroup Inc. wrote in a May 17 report. “We fully expect to see companies taking a more aggressive approach to prefunding their 2014 maturities,” capital expenditures and mergers, especially if discussion of the Fed withdrawing stimulus continues, they wrote.
Federal Reserve Bank of San Francisco President John Williams said last week that quickening economic growth and gains in the job market may prompt the Fed in the next few months to start reducing bond buying.
“It’s clear that the labor market has improved since September” when the Fed began its third round of asset purchases, Williams said in a May 16 speech in Portland, Oregon. “We could reduce somewhat the pace of our securities purchases, perhaps as early as this summer” and end the program late this year “if all goes as hoped.”
Refinancing Purposes
Of investment-grade companies selling debt in the U.S. in April, 70% specified refinancing among their use of proceeds, 10% cited mergers-and-acquisitions activity, 23% shareholder payments and 3% capital spending, according to Lonski of Moody’s. Use of offerings can fall into more than one category, while the figures exclude sales designated for general corporate purposes.
The number of junk-rated companies that are under liquidity stress was at almost all-time low levels this month as strong investor demand allows firms to shore up cash, according to a May 16 report from Moody’s.
“Most U.S. speculative-grade companies are avoiding liquidity problems despite tepid growth in corporate sales and continued softness in the economy,” Moody’s analysts led by John Puchalla wrote.
The ratings company’s Liquidity-Stress Index, which falls when corporations’ ability to manage cash needs appears to improve and rises when it weakens, is at about an unprecedented low, reaching 3.2% in mid-May from a record 2.8% at the end of April, according to the report. That compares with an historic average of 7.3%.
“Conditions for issuers could not be more ideal,” wrote Shoup of Citigroup. “How much longer the party lasts is the billion dollar question.”
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