WSJ: Junk Bonds Feed a Hungry Market

Thanks to Mark Hanna at Market Montage:

The below WSJ article notes that companies with junk credit ratings are piling into the debt markets at a record pace, seizing on some of the lowest borrowing costs in history and strong demand from investors craving higher returns.

This rally in junk bonds began in early 2009 and can be traced almost entirely to the Fed’s policy of keeping benchark interest rates at/near zero.

Many companies and investors have benefited. Many corporate borrowers have been able to refinance debt at much lower rates, and others have been able to raise money cheaply for investments.

But are there unintended consequences and is this just another bubble waiting to pop?

Major takeaways:

  • Some 130 U.S. junk-rated companies have sold $75B in junk bonds this quarter, up 12% from the same period last year and a record for any quarter going back to 1980.
  • For the most part, companies are using money from the debt sales simply to refinance existing debt, or they are hoarding the cash.
  • Savers and investors have been flooding into junk bondssearching for investments that yield more than the meager rates offered by Treasurys and investment-grade corporate bonds.
  • High-yield corporate borrowers paid an average rate of 7.98% on bonds they have sold this year – the lowest since the junk-bond market was created in the 1980s (versus yields of little more than 1% on comparable Treasury notes and an average of about 3.4% on all investment-grade bonds)
  • This year, investors poured a record $18.6B into high-yield mutual funds and exchange-traded funds through March 26 – exceeding the previous record $12.8B set in the fourth quarter last year.

http://online.wsj.com/article/SB10001424052702304177104577311923227522232.html?KEYWORDS=Junk+Bonds+Feed+a+Hungry+Market

Junk Bonds Feed a Hungry Market

By MATT WIRZ

U.S. companies with junk credit ratings are piling into the debt markets at a record pace, seizing on some of the lowest borrowing costs in history and strong demand from investors craving higher returns.

Companies and investors both have benefited. Many corporate borrowers have been able to refinance debt at much lower rates, and others have been able to raise money cheaply for investments. And so-called junk bonds, those with below-investment-grade credit ratings, have handed investors among the best returns of any fixed-income asset this year, according to Barclays PLC. Junk bonds pay higher yields because they are considered riskier investments.

Some 130 U.S. junk-rated companies, from commercial lender CIT Group Inc. to car-rental company Hertz Global Holdings Inc., have sold $75 billion in junk bonds this quarter, according to Thomson Reuters, up 12% from the same period last year and a record for any quarter going back to 1980 when Thomson began keeping data. “This is nirvana” for many low-rated companies, said Jim Casey, co-head of global debt capital markets at J.P. Morgan Chase & Co.

The rally in junk bonds extends an advance that began in early 2009 and can be traced largely to the Federal Reserve’s policy of keeping benchmark interest rates near zero. Activity recently has picked up, bankers say, in part because some corporate finance chiefs are starting to worry that interest rates may be about to rise, despite comments by Fed Chairman Ben Bernanke that rates will remain low for some time. Bond prices move inversely to yields.

The boom in junk coincides with a return in appetite for riskier investments. In the stock market, the Dow Jones Industrial Average is up 7.6% this year and this week is on pace to be the busiest for initial public offerings since late 2007.

Investors of all stripes have been diving into junk. Many of them are searching for investments that yield more than the meager rates offered by Treasurys and investment-grade corporate bonds. They are flooding into high-yield mutual funds and exchange-traded funds, market data show.

“It’s the only place I can find any yield whatsoever with a reasonable risk,” said Lee Hevner, an individual investor who said he started buying junk bonds this year for the first time. In January he put about 15% of his $500,000 savings into an exchange-traded fund that holds junk bonds.

Some analysts warn that interest rates may soon begin rising, even though the Fed aims to keep them low. That would boost the cost of borrowing. It also would drive down prices of junk bonds. Because these are bonds of some of the riskiest companies, they also would leave investors vulnerable to defaults should the economy falter.

For now, though, the bonanza continues.

High-yield corporate borrowers paid an average rate of 7.98% on bonds they have sold this year, according to Thomson Reuters. That is the lowest since the junk-bond market was created in the 1980s. That compares with yields of little more than 1% on comparable Treasury notes and an average of about 3.4% on all investment-grade bonds, based on the Barclays Aggregate Bond index.

For the most part, companies are using money from the debt sales simply to refinance existing debt, or they are hoarding the cash, data show. But some market observers say that could change soon as companies start using the money for mergers or expansion. Eventually that will also help the economy, said Mr. Casey of J.P. Morgan.

“You’re putting companies in better position to grow because they will be more willing to take on that debt to pursue their projects,” he said.

For some companies, the interest-rate decline over the past few years has been stark. CIT, which emerged from bankruptcy protection in December 2009, two weeks ago sold $1.5 billion of bonds maturing in six years with a yield of 5.25%. That is less than the 5.8% CIT paid on similar debt in 2006, when it was rated investment grade. A CIT spokesman declined to comment.

Oklahoma City-based Continental Resources Inc., an oil producer, sold its first bond in September 2009, a 10-year note, with an 8.4% yield, following up in 2010 with two 10-year bonds yielding 7.5% and 7.125%.

But in early March, Continental sold its largest bond ever, raising $800 million at a yield of 5%. The low rate the company paid reflects its improving credit quality—the company has had credit-rating upgrades—and rapidly expanding production. But it also shows the unusual market conditions for high-yield borrowers, said John Hart, Continental’s chief financial officer.

“A lot of money is flowing in, and a lot of it is coming in because it’s a better investment opportunity,” he said.

Ford Motor Credit Co., a unit of Ford Motor Co., paid 4% to borrow for three years in January, and Victoria’s Secret owner Limited Brands Inc. sold a 10-year bond at 5.625% in February.

Linn Energy LLC is among companies selling bonds to pay for acquisitions. The company raised $1.8 billion in late February to fund the purchase of oil fields. “The lower cost of capital allows us to be pretty competitive,” said Linn Chairman and Chief Executive Mark Ellis.

The low yields are largely due to record-low rates on Treasurys, which form the benchmark for most other interest rates.

This year, investors poured a record $18.6 billion into high-yield mutual funds and exchange-traded funds through March 26, according to Lipper Inc. That exceeded the previous record $12.8 billion set in the fourth quarter last year.

But investors run the risk of having the tide turn against them should interest rates start rising. Some analysts have begun suggesting that day could come soon.

“This is the talk of the market,” said Matt Conti, who helps manage $50 billion of high-yield investments at Fidelity Investments. “My general view is it’s time to be defensive.”

That concern may be reflected in part in the extra yield investors demand to own junk bonds. Junk bonds yield an average 6.08 percentage points above comparable Treasurys, according to Barclays indexes. That still is well above the record low of about 2.5 percentage points reached in mid-2007.

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