Junk Status Holds No Fear and Today’s Other Top Stories

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There was a time that companies would move hell and highwater to keep their credit rating above the BB junk threshold. But now, companies that were once fiercely proud of their investment grade status, are flirting with the idea of leveraging up on debt, to the detriment of their credit rating.

Bloomberg reports today, that with rates so low, junk status simply doesn’t punish a company like it once did. With the financial repression by central banks continuing for a sixth year, funding costs for speculative-grade borrowers are converging with those of higher-ranked issuers.

For example, companies with the highest junk grades are paying only 1.5 percentage points more, on average, than firms deemed investment-grade, that’s the slimmest margin since 2009 and down from a gap of 3 percentage points two years ago.

Average yields on bonds in the BB tier due in five to seven years dropped to 4.94 percent yesterday, approaching the record-low 4.8 percent reached a year ago, according to Bank of America Merrill Lynch index data. Similar-maturity notes rated BBB pay 3.41 percent.

“As long as money’s cheap, there’s no incentive for a company to de-leverage,” Alan Cauberghs, the London-based investment director for fixed income at Schroders Plc, which oversees more than $400 billion, said yesterday in an interview in New York. “Companies can finance themselves at extremely attractive rates.”

The market is encouraging companies to be “more aggressive with their balance sheets,” Morgan Stanley analysts led by Sivan Mahadevan wrote in a May 16 report. “The cost of moving down the credit ratings spectrum is not nearly as high as it once was.”

Investors clamouring for yield have pushed high-yield bonds to the point where they are “extremely overvalued”, according to Marty Fridson, chief investment officer of Lehmann, Livian, Fridson Advisors LLC.

“Monetary policy is the key to the present, extended period of overvaluation,” Fridson wrote. “Investors are accepting excessively small compensation for credit risk, so desperate are they to boost their yields.”

And the current situation is looks set to continue for a while yet. With New York Fed President Dudley telling reporters yesterday that the pace of eventual interest rate increases “will probably be relatively slow,” depending on the economy’s progress and how financial markets react.

“With low risk-free yields and quantitative easing still the Fed’s operative policy, there will continue to be a global scramble for assets with yield,” said Edward Marrinan, a credit strategist at RBS Securities in Stamford, Connecticut.


Todays Other Top Stories

Municipal Bonds

Bloomberg: – California drought won’t hurt muni finances, Moody’s says. – California’s drought won’t affect the creditworthiness of the state or most of its local governments, Moody’s Investors Service said.

ETF Trends: – It may be time to scale back on high-yield muni ETFs. – High-yield municipal bonds and related exchange traded funds have been rallying alongside the strongest run-up in speculative debt since 2009, and now, Morgan Stanley (NYSE: MS) is sounding a warning.

Bloomberg: – NYC’s rising labor costs prod UBS to sell: Muni credit. – New York Mayor Bill de Blasio’s plan to pay for labor contracts that boost deficits is causing UBS Global Asset Management Americas Inc. and RidgeWorth Capital Management Inc. to reduce holdings of city debt.

Bloomberg: – N.J. has 13-month shortage of $2.7 billion, analyst says. – New Jersey faces a deficit of almost $2.7 billion over the next 13 months, the legislature’s budget and finance officer told lawmakers a day after Governor Chris Christie announced pension cuts to balance two budgets.

NJ Spotlight: – Why NJ’s bond rating was downgraded and why it matters. – Higher interest rates resulting from shaky credit status means it will cost more for the state to borrow money.

Bloomberg: – Atlanta Transit Authority Plans $300 Million Bond Sale. – Metro Atlanta Rapid Transit Authority, which operates the Georgia city’s public transportation system, will sell $300 million of revenue bonds next month to pay for capital improvements and refinance short-term loans.


Treasury Bonds

LearnBonds: – Will the 10-year Treasury yield continue to drop? – With significant selling coming into the beginning of the year, there didn’t seem to be many market watchers predicting the rally in bonds we’ve seen over the past five months. Indeed, with the Fed plodding along with the taper, and speculation that short-term rates could potentially tighten in 2015, the 10-year’s move from 3 to 2.5% this year was widely unanticipated.

Businessweek: – Treasuries advance first time in 3 days as risk appetite shrinks. – Treasuries rose, with 10-year note yields trading at almost a six-month low, as risk appetite declined before the Federal Reserve releases minutes tomorrow of its April policy meeting.

Financial Post: – What’s driving 10-year treasury yields lower? – Since equity investors frequently view treasury yields as a key indicator of economic health, RBC Capital Markets chief strategist Jonathan Golub decided to take a closer look at what’s behind the move in U.S. 10-year government bonds.

MarketWatch: – It’s time to short Treasurys. – Bonds have commanded tremendous attention so far in 2014. After getting pummeled last summer and leaving most investors scrambling to adjust for higher and higher interest rates, the long bond has come back to rear its ugly head.


Corporate Bonds

Businessweek: – The cheap PIMCO fund that has Gross reaching for his wallet. – Billionaire Bill Gross can’t resist this rarity: A slice of the corporate debt market that still looks cheap.


High Yield Bonds

Sedgwick County: – Warning signs for junk-bond investors. – Junk bonds have been strong investments since the recession, and investors continue to pile into the market. But fund managers say they’re looking less attractive. Many are taking a step back and urging investors at least to temper their expectations.

Income Investing: – Investors flock to junk bonds, while loan funds fall from favor. – The demand for low-rated debt is raising concerns that investors are stockpiling future risk. Kathleen Gaffney, portfolio manager of the $700 million Eaton Vance Bond Fund, says recent buyers could be hit when rates eventually rise—which would drive down bond prices.

WSJ: – Chasing yield, investors plow into junk bonds. – Large investors are rushing into the riskiest corporate bonds, frustrated by low interest rates on safer investments and convinced that even companies with shaky finances are in little danger of default. Colin Barr joins MoneyBeat.

Income Investing: – Junk bonds now ‘Way, way overvalued’ – Fridson. – With the Wall Street Journal taking a front-page look at insatiable investor demand for low-rated junk bonds, high-yield market guru Martin Fridson weighs in on the issue this afternoon, saying he’s upgraded his assessment of junk bonds from “way overvalued” to “way, way overvalued.”

The Growth Stock Wire: – Bond investors are making a bad bet right now. – We can look at the crazy valuations of Internet stocks during the dot-com era and the housing bubble of 2006 as a couple good examples.

Henderson: – Henderson’s high yield opportunities fund update. – Kevin Loome, CFA, Head of US Credit reviews the High Yield Opportunities Fund’s (HYOAX) first year of performance noting the success of both asset allocation and credit selection.

Businessweek: – Leverage beckons as penalty for junk loses bite. – The way DigitalGlobe Inc. Chief Financial Officer Yancey Spruill sees it, credit investors are giving his company little reason to rush paying down debt that more than doubled after the satellite-imaging firm bought a competitor last year.

Morningstar: – High yield bonds: Where to invest. – Emerging market high yield bonds have underperformed their developed market counterparts – creating a buying opportunity according to fixed income experts.


Investment Strategy

Financial Post: – Managers prepare for bond yields to rise. – Jeff Herold and Maria Berlettano continue to have a defensive stance for the NexGen Canadian Bond Fund, despite seeing some attractive opportunities in the bond market in anticipation of more restrictive monetary policy.

ValueWalk: – Interest rates have to go up. The “bond king” says no. – The prevailing view on Wall Street and Main Street is that medium and long-term interest rates have to go higher in the months and years ahead. Interest rates have to get back to “normal” at some point, so we’re told. Yet in the last several months, yields on 10-year Treasury notes and 30-year Treasury bonds have fallen rather significantly. What’s up with that?


Bond Funds

Chron: – It’s twilight for managed mutual funds. – It doesn’t matter how many pages of advertising they take out in the glossy financial magazines, or how many ads they buy on television. It doesn’t even matter how many salespeople they send out disguised as financial advisers. Managed equity funds are on the way out. Today, low-cost index funds are what investors choose – for many good reasons.

CNBC: – Danger of investing in inverse and leveraged ETFs. – Many investors have piled into Proshares Ultrashort 20+ Year Treasury(TBT) ETF, anticipating that long-term bond prices would be dropping, and yields would be rising. So far, they have been disappointed.

WSJ: – Worries of a bank-loan-ETF exodus mount. – Investors have been pulling money out of exchange-traded funds backed by bank loans, once again raising concerns about the ability of lightly traded financial markets to handle a big exodus from ETFs.

WSJ:  – Long-term mutual fund inflows $4.06 billion in latest week. – Long-term mutual funds had estimated inflows of $4.06 billion in the latest week as investors continued to add to bonds and world stock funds and pull out of U.S. stock funds, according to the Investment Company Institute.




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