Bloomberg News

T. Rowe Sees Food Fight Over Newest Junk Bonds: Credit Markets

August 06, 2012

T. Rowe Sees Food Fight Over Newest Junk Bonds

B/E Aerospace Inc., the maker of premium seating used on Deutsche Lufthansa AG’s 747-8 airplanes sold $800 million more of the notes in a reopening on July 12, up from the $675 million initially planned. Photographer: Hannelore Foerster/Bloomberg

The value of new junk bonds is rising by the most in at least three years relative to outstanding debt as low trading volume and faster cash inflows into mutual funds force investors to jockey for initial offerings.

New speculative-grade issues have outperformed Barclays Plc’s high-yield index by about 1.8 percent this year, more than in 2011 and 2010. Notes from Smithfield, Virginia-based Smithfield Foods Inc. (SFD:US), the largest U.S. pork processor, rose 5.8 cents to 105.3 cents on the dollar since being sold July 18, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Junk-bond fund managers that have received $43.1 billion of deposits this year are struggling to obtain securities as trading volumes decline, reducing the accessibility of older bonds. The squeeze is exacerbated by a 54 percent drop in monthly debt sales since May, data compiled by Bloomberg show.

It’s “a food fight” for new issues, said Mark Vaselkiv, president of the $9.36 billion T. Rowe Price High Yield Fund. “The major dynamic that’s affecting the market is a relative scarcity of good quality product. Many of the major high-yield managers are struggling to stay fully invested.”

Beating Stocks

High-yield, high-risk bonds, graded below Baa3 by Moody’s Investors Service and lower than BBB- at Standard & Poor’s, have returned 9.45 percent this year, including reinvested interest, Bank of America Merrill Lynch indexes show, compared with 8.82 percent for the Dow Jones Industrial Average when including dividends.

Investors are looking further down the credit spectrum in search of returns as the Federal Reserve holds benchmark interest rates near zero through at least late 2014 to help jump-start an economy in which the unemployment rate has held at 8 percent or more for 42 months.

Junk-bond funds received $9.32 billion of inflows in July, the most since February, EPFR Global data show.

“Demand is intense” and the allocations of new bonds “are finite,” Martin Fridson, a global credit strategist in New York at BNP Paribas Investment Partners, said in a telephone interview. “It’s become tough to buy the acceptable quality paper that the portfolio managers want to own.”

Elsewhere in credit markets, the cost of protecting corporate debt from default in the U.S. fell, with the Markit CDX North America Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, declining 1.2 basis points to a mid-price of 102.3 basis points as of 11:14 a.m. in New York, according to prices compiled by Bloomberg.

Rate Swaps

That’s the lowest level on an intra-day basis since May 10 for the measure, which typically falls as investor confidence improves and rises 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 contract protecting $10 million of debt.

The U.S. two-year interest-rate swap spread, a measure of bond market stress, decreased 0.75 basis point to 20 basis points as of 11:14 a.m. in New York. The gauge narrows when investors favor assets such as corporate bonds and widens when they seek the perceived safety of government securities.

Bonds of Caracas-based Petroleos de Venezuela SA, or PDVSA, are the most actively traded dollar-denominated corporate securities by dealers today, with 50 trades of $1 million or more as of 11:07 a.m. in New York, Trace data show.

Smithfield Bonds

Recently issued speculative-grade securities have returned 1.8 percent more than the Barclays U.S. High Yield Index this year, compared with 1.71 percent last year and 1.28 percent in 2010. About half of the outperformance came in the first day of trading, according to an Aug. 3 report by Barclays analysts led by Jeffrey Meli and Bradley Rogoff.

“Managers like ourselves that don’t get the allocations they want will go back into the secondary market to fill out orders,” T. Rowe’s Vaselkiv said in a telephone interview. “We typically end up paying more than the offering price to fill out allocations.”

Smithfield sold $1 billion of 6.625 percent, 10-year notes on July 18 in the company’s first debt sale in more than three years, increasing the size from $650 million, a person familiar with the transaction said at the time of the deal who asked not to be identified because the terms are private.

The bonds were sold at a spread of 515 basis points more than similar-maturity U.S. Treasuries, 101 basis points less than the relative yield on Smithfield’s June 2009 sale of $850 million of 10 percent securities due in July 2014.

Cash Inflows

Demand for larger returns has induced investors to seek out the debt of high-yield, high-risk companies such as New York- based CIT Group Inc. (CIT:US), the small-business lender that exited bankruptcy two years ago, pushing yields on the firm’s bonds lower than the average for all investment-grade debt.

The company’s $1.5 billion of 4.75 percent notes sold in February traded at 104.2 cents on the dollar Aug. 3 for a yield of 3.01 percent, Bloomberg prices show, compared with average yields on all investment-grade debt of 3.08 percent based on Bank of America Merrill Lynch’s U.S. Corporate Master index.

B/E Aerospace Inc. (BEAV:US) sold $500 million of 5.25 percent, 10- year notes on March 8, after increasing the offering from $375 million, the Wellington, Florida-based company said in a statement at the time. The maker of premium seating used on Deutsche Lufthansa AG’s 747-8 airplanes sold $800 million more of the notes in a reopening on July 12, up from the $675 million initially planned.

The notes, priced at par in the first sale, have climbed to 106.3 cents on the dollar, Trace data show.

Sales Drop

“You’re seeing cash come into this market hand over fist,” Peter Toal, the head of Americas leveraged finance syndicate at Barclays in New York, said in a telephone interview. “When you have deals that are multiple times over- subscribed, you can’t feed everybody.”

High-yield bond issuance has slowed as Europe’s debt crisis intensified and a weakening U.S. economy deterred companies from raising money. Sales declined to a monthly average of $13.8 billion in May and June from $29.9 billion of debt in January through April.

Cash-like investments accounted for an average 7.7 percent of high-yield bond funds’ assets at the end of June, 2.6 percentage points more than a year earlier, according to data from the Investment Company Institute in Washington.

“As the inflows have accelerated, the competitiveness of bidders for new issues has intensified,” Fridson said. “It’s not easy to buy the paper you want to buy in the secondary market because things have been tight for a while and so that makes the new-issue market the place to put money to work.”

To contact the reporters on this story: Lisa Abramowicz in New York at labramowicz@bloomberg.net; Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net

B/E Aerospace Inc., the maker of premium seating used on Deutsche Lufthansa AG’s 747-8 airplanes sold $800 million more of the notes in a reopening on July 12, up from the $675 million initially planned. Photographer: Hannelore Foerster/Bloomberg

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Companies Mentioned

  • CIT
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