Junk bond risks are increasing at a time when valuations are at record highs. According to a report by Deutsche Bank AG, the junkiest corporate debt in the U.S. isn’t growing fast enough to pay down their borrowings, increasing the risk for investors.
The bank says this is despite the biggest jump in earnings in almost three years as the amount of debt on balance sheets climbs back to levels seen in early 2008 before the financial crisis. To make matters worse, their ability to make interest payments is about where it was in 2007, even as the Federal Reserve has held its benchmark rate close to zero.
This spells bad news for Investors who have piled into the riskiest end of the junk bond market in desperate search of yield. The subsequent pressure on yields has allowed the least creditworthy borrowers to raise $1.64 trillion in the bond market since the end of 2008, according to data compiled by Bloomberg.
More from Bloomberg: Even with historically low borrowing costs, the ability of companies to make interest payments is about the same as before the global financial crisis. Coverage ratios, a measure of earnings to interest expense, average about 4 times for U.S. high-yield companies, compared with an average of 3.8 times in 2007 and early 2008, according to Deutsche Bank. Companies with lower ratios have higher debt burdens.
While the Fed stopped buying bonds last month under a program known as quantitative easing, it pledged to keep interest rates low for a “considerable time.”
“We’re closer to the end of the credit cycle, but we’re not quite there,” said Scott Colyer, chief executive officer of Monument, Colorado-based Advisors Asset Management Inc., which oversees more than $15 billion. “That usually comes when the Fed is trying to slow down a powerful economy. At this point in time, I don’t see it.”
Todays Other Top Stories
Learn Bonds: – Learn to be a good judge of bond risk. – Investors are constantly in search of securities commensurate with the amount of risk they are willing to take. While bonds cannot be classified as risk-free given the omnipresent potential for default, they are a contractual obligation between borrower and lender. And since bonds sit higher in a corporation’s capital structure than equity shares, they are generally viewed as more secure than common stock.
Bond Buyer: – SEC’s top cop: More muni enforcement, not less. – The municipal market should expect increased attention from the Securities and Exchange Commission’s enforcement division, with a focus on pension fund abuses and pay to play violations, and undisclosed conflicts of interest, the SEC’s top cop said Monday.
Bond Case Briefs: – Michigan city settles SEC fraud charges in municipal bond sale. – The city of Allen Park, Mich., and two of its former officials settled fraud charges related to the sale of a $31 million municipal bond issue to raise funds for a movie studio project to spur needed economic development, according to the Securities and Exchange Commission.
Benzinga: – Why Detroit won’t open a ‘floodgate’ of municipal bankruptcies. – While there could be more bankruptcies because of the number of cities in distressed conditions, most cities do a reasonable job of curtailing expenses and getting revenues up. Detroit will not open a floodgate of municipal bankruptcies.
MMA: – Municipal market brief. – Read MMA Municipal Issuer Brief’s take on green municipal bonds & the pros & cons of issuing them here.
MarketWatch: –Bond market liquidity seen moving toward asset managers. – Asset managers are planning to hold more cash and large liquid bonds as broker/dealers’ importance in providing liquidity to the fixed income markets has diminished, according to a Fitch Ratings survey of major asset managers. The changes are a natural offshoot of banking regulations that have reduced broker/dealer inventories of corporate and municipal bonds.
Bloomberg: – Treasury urges issuers, buyers to make benchmark MBS. – The U.S. Treasury is urging mortgage-bond sellers and large investors to come together to help jumpstart issuance with a sale of at least $1 billion of the securities without government backing.
FT Adviser: – Investment hopes are in the offing. – (Subscription). Markets are finally contemplating the possibility that central banks may soon start raising interest rates from these historically low levels. With strong data from both economies, and outspoken central bankers anticipating an interest rate rise in the first half of next year, markets have had plenty of warning signals and time to prepare.
Elliott Wave: – U.S. Treasuries: What happened on October 15? – High-frequency trading may have been one reason for the turmoil. Or was it something else?
Bloomberg: – Long-term treasuries are best performers before 10-year auction. – Long-term Treasuries are the best-performing government bonds for international investors this year, with the U.S. scheduled to sell $24 billion in 10-year notes.
FT Adviser: – Low interest rates and soaring debts trigger rise in bond prices. – (Subscription) The macroeconomic environment has been somewhat unpredictable for fixed income, particularly government bonds, in the past few years.
CNBC: – Is Apple disrupting the U.S. bond market? – Why are U.S. companies rushing to Europe? While companies with operations in Europe could have natural reasons to raise money there, there’s another motivation that’s purely financial. Yields on investment grade bonds denominated in euros are about 1.6 percentage points lower than similar bonds priced in dollars, according to data from Citigroup. That’s the widest gap since 2006.
High Yield Bonds
Market Realist: – Why high yield debt is staging a comeback in the capital markets. – Issuance in high yield or junk bond markets has staged a recovery over the past three weeks. Market conditions strengthened and bullish economic data turned things around for junk bond issuers.
Bloomberg: – Billionaire Corona beer heir mesmerizes junk bond buyers. – Maria Asuncion Aramburuzabala, whose family was part of the group that sold a controlling stake in Corona beer maker Grupo Modelo SAB for $20.1 billion last year, is proving her name carries weight in the bond market.
Bloomberg: – Junk bond risks escalate with leverage back to ’08 levels. – The riskiest corporate debtors in the U.S. aren’t growing fast enough to pay down their borrowings, increasing the risk for bond investors at a time when valuations are already at about record highs.
FT: – High-yield supply scarce despite fresh record. – (Subscription) Issuance in European high-yield bonds has already exceeded last year’s record total – despite a sharp reduction in the number of new bonds being issued since recent market wobbles.
Financial Lexicon: – AMD’s high-yielding bonds now offer 8% to 9%. – There are four separate issues of AMD bonds trading in the secondary market. These non-investment grade rated securities currently offer yields in the 8% and 9% range, a respectable return for investors who believe AMD can avoid default in the years to come.
Citywire Global: – High hopes for high yield: five reasons to back the beaten-up sector. – Despite experiencing its worst Q3 for three years, Western Asset’s head of global credit Michael Buchanan believes there is hope for high yield.
PIMCO: – PIMCO target maturity emerging markets strategy. – In an environment of lower than historically expected yields, investors continue to be drawn to emerging markets as they offer a yield advantage with generally better fundamentals.
FT: – Mexico’s move set to shake up bond market. – (Subscription) Mexico is ushering in the next generation of government debt with changes that could shift the balance of power away from so-called vulture fund investors and prevent a repeat of Argentina’s debt crisis.
Businessweek: – Argentina price controls shield YPF bonds from oil plunge. – President Cristina Fernandez de Kirchner’s domestic price controls are shielding bondholders of Argentina’s state-run oil company from the bear market in crude.
Artemis: – Anticipation stimulates secondary cat bond & ILS trading in October. – The anticipation of a brisk last two months of the year, with reports that a number of billion dollars worth of new catastrophe bonds may come to market, stimulated secondary ILS trading activity in October despite the primary market remaining quiet.
Sun Sentinel: – Is your investment portfolio really diversified? – Nearly everyone who invests in equities knows that an investment portfolio needs to be diversified, in order to help balance some of the risks of various investments. There is a problem because most people don’t understand that there are many forms of diversification. Diversification does not really protect you from market losses, and over long periods of time, diversification is guaranteed to cost you money, compared to alternative methods of portfolio protection.
AllianceBernstein: – Is levering bonds a loser’s game today? – Multi-asset strategies like risk parity owe much of their popularity to their ability to navigate the global financial crisis. Lately, critics have cited levered bond returns as the driver—and as a looming headwind. We think they’re missing a key point.
Businessweek: – BlackRock takes Pimco assets with No. 1 Rieder fund. – At a BlackRock (BLK:US) event last week in New York, fund manager Rick Rieder told about 100 advisers that he expects interest rates to remain low as aging Baby Boomers seek the stability of fixed-income investments. The talk was enough to persuade Larry Glazer to shift even more client money from Pimco to Rieder’s BlackRock fund.
ETF.com: – Finding the right int’l bond ETF. – I think investors all too often get so caught up in chasing what they think is going to be hot next year, that they forget the fundamental premises of modern portfolio theory. You want to own assets that aren’t correlated, so that when one zigs, the other—hopefully—zags. Combining non-alike assets is a surefire winner for long-term risk management. International bonds fit the bill in spades. Consider how the market stacks up in just one corner of the bond market—corporates.
ETF Trends: – Short-term bond ETFs: Cool kids at the fixed income party. – Although U.S. stocks are soaring to record highs, fixed income exchange traded funds are the apples of investors’ eyes.
UST mkt volume now 190bln 10yr equivs…crazy quiet for a 10yr auction day…the big players must still be on vaca.
— govttrader (@govttrader) November 12, 2014
New asset allocation making the rounds on the sell side: 55% stocks, 35% bonds, and 10% BABA
— David Schawel (@DavidSchawel) November 12, 2014
Feels like bonds are going to close the day materially lower in price. Been a slow leak since 10AM.
— Tom Graff (@tdgraff) November 12, 2014
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