Bloomberg News

Junk Fervor Blinds Buyers as Loan Gap Vanishes: Credit Markets

September 18, 2012

Junk Fervor Blinds Buyers as Loan Gap Vanishes

Elsewhere in credit markets, Nordea Bank AB, the Nordic region’s largest lender, raised $1 billion of subordinated debt in its first offering of dollar-denominated 10-year bonds in more than 16 months. Photographer: Tomm W. Christiansen/Bloomberg

Investors are so attracted to junk bonds that they’re accepting less compensation than holders of loans, which get paid first in bankruptcies.

Yields on U.S. speculative-grade notes have fallen to 6.29 percent, 1 basis point less than a measure of what’s being paid by senior secured loans, according to JPMorgan Chase & Co. (JPM:US) That’s the first time the gap has vanished, with junk bonds paying an average 103 basis points, or 1.03 percentage points, more than loans over the past three years, JPMorgan data show.

Junk-bond buyers are demanding lower yields to take on greater risk as they seek alternatives to Treasuries paying the least ever. Investors have unleashed an unprecedented flood of cash into the junk-bond market this year that’s almost 18 times the deposits into funds that buy floating-rate loans, as the Federal Reverse said it expects to keep its target interest rate near zero for at least another three years.

“It doesn’t make sense,” said Bonnie Baha, head of global developed credit at Los Angeles-based DoubleLine Capital LP that oversees $40 billion of assets. “You would expect loans to be much tighter than they are relative to high yield. The flows into the credit markets have really distorted pricing and valuation.”

Speculative-grade bonds have gained 7.3 percent since the end of May compared with 5.1 percent for loans in the same ratings tiers, according to Bank of America Merrill Lynch and Standard & Poor’s/LSTA U.S. Leveraged Loan index data.

Sales Surge

Junk-rated sales are off to the best-ever start for a September, data compiled by Bloomberg show.

The demand has pushed yields on the debt, ranked below Baa3 by Moody’s Investors Service and BBB- by S&P, to a record low even as the default rate for speculative-grade companies globally rises to almost double last year’s level.

“The loan market is pricing in a yield to investors that suggests a materially higher default rate than the high-yield bond market,” said John Popp, global head and chief investment officer of Credit Suisse Group AG (CSGN)’s credit investments group, which oversees about $17.5 billion of mostly speculative-grade debt. “On a pure credit-spread basis, loans look quite cheap.”

Harley Bonds

Elsewhere in credit markets, a unit of Harley-Davidson Inc., the biggest U.S. motorcycle maker, plans to sell three- year bonds after Moody’s raised its rating outlook to positive. RadNet Inc., an operator of outpatient diagnostic-imaging centers, is seeking a credit facility of as much $455 million to refinance debt.

The Markit CDX North America Investment-Grade index, a credit-swaps benchmark tied to the debt of 125 companies in the U.S. and Canada, was little changed after rising yesterday from an 18-month low. The index declined 0.3 basis point to 84.9 basis points as of 11:25 a.m. in New York, according to prices compiled by Bloomberg. It ended last week at 83 basis points, the lowest since March 2011.

In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings increased 2.3 to 122.7.

The indexes typically rise as investor confidence deteriorates and fall as it improves. Credit 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.

Swap Spreads

The U.S. two-year interest-rate swap spread, a measure of debt-market stress, increased 1.46 basis points to 14.01 basis points. It ended last week at 12.31, the tightest since March 2010.

The gauge widens when investors seek the perceived safety of government securities and narrows when they favor assets such as company debentures.

Bonds of Fairfield, Connecticut-based General Electric Co. are the most actively traded dollar-denominated corporate securities by dealers today, with 55 trades of $1 million or more as of 11:27 a.m. in New York, according to Trace, the bond- price reporting system of the Financial Industry Regulatory Authority.

Harley-Davidson Financial Services may sell bonds as soon as today in benchmark size, typically at least $500 million, according to a person familiar with the offering who asked not to be identified because terms aren’t set.

Moody’s, which grades the company Baa1 or three-levels more than junk, revised its outlook yesterday citing more labor flexibility and improving operating efficiencies. S&P increased its rating on the Milwaukee, Wisconsin-based company to BBB+ from BBB on Jan. 25.

RadNet Loan

RadNet (RDNT:US) plans to pay off its term loan and a portion the existing balance on its revolving credit line with as much as $330 million in term loans, the Los Angeles-based company said today in a statement. As of June 30, RadNet had about $338 million of loans outstanding, consisting of $278.6 million of term debt and $59.5 million under its revolver, according to the statement.

RadNet, which operates 237 imaging centers in states including New York, New Jersey and California, said it’s also seeking a new revolving loan of between $100 million and $125 million. Under a revolver, money can be borrowed again once it’s repaid; in a term loan, it can’t.

The S&P/LSTA leveraged loan index rose for the 10th day, gaining 0.14 cent to 96.3 cents on the dollar, the highest level since Feb. 22, 2011. The measure, which tracks the 100 largest dollar-denominated first-lien leveraged loans, has climbed from 91.8 on June 5, the lowest since Jan. 6.

‘Reach for Yield’

Leveraged loans, which typically rank ahead of bonds in a company’s capital structure, are yielding 6.3 percent, 0.1 percentage point more than high-yield bonds, according to a Sept. 14 report from JPMorgan analysts led by Peter Acciavatti. Junk notes historically have higher yields than loans, with the difference between yields on the debt climbing beyond 300 basis points in 2009, the report said.

“Bonds have benefited to a slightly larger degree from the reach for yield and popularity,” wrote the New York-based analysts. “We expect this relationship to garner additional attention in the near future, and allocations toward loans by high-yield managers to continue to increase.”

Investors have funneled $55.9 billion into high-yield bond funds globally this year through Sept. 12, breaking the previous record set in 2009 by $24.1 billion, according to data compiled by Cambridge, Massachusetts-based EPFR Global. Loan funds have reported $3.18 billion of deposits this year, less than one- third the record volume of 2010, the data show.

Buyer Pools

“From a pure credit standpoint, you’re taking less risk in loans due to their higher average recovery,” said Michael Kessler, a credit strategist at Barclays Plc in New York.

The pools of buyers who invest in the two classes of the debt tend to be separate, though, with many of the individuals that have helped fuel record junk-bond inflows being less familiar with loans, he said.

In one potential headwind for loans, Barclays estimates that over the next four years investors will have to absorb about $160 billion of the debt as collateralized loan obligations, which own about 50 percent of leveraged loans outstanding, are set to wind down their investment periods, according to Kessler.

“Hopefully most that will come from new CLO creation,” he said.

CLOs are a type of collateralized debt obligation that pool high-yield loans and slice them into securities of varying risk and returns.

Growth Forecasts

There have been $25.8 billion of CLOs backed by widely syndicated loans raised in the U.S. this year, the most since 2007, according to Bloomberg and Morgan Stanley data. JPMorgan increased its CLO forecast for 2012 by $5 billion to $35 billion and said there may be $50 billion to $60 billion of the funds raised next year.

Junk buyers are being encouraged as the Fed announced last week a third round of bond-buying to combat an unemployment rate stuck above 8 percent since February 2009.

The central bank plans to expand its holdings of long-term securities with open-ended purchases of $40 billion of mortgage debt a month as economists surveyed by Bloomberg predict that U.S. economic expansion will probably slow to a pace of 2.05 percent in 2013 versus a growth rate of 2.2 percent this year.

The Fed also said it will probably hold the federal funds rate near zero “at least through mid-2015.”

Speculative-grade companies have sold $20.1 billion of notes in the U.S. this month, Bloomberg data show. Borrowers issued $1.6 billion of leveraged loans in September versus $11.2 billion during the same period last year, the data show.

Companies are selling the debt as credit-ratings downgrades outpace upgrades for the first time since 2009, S&P data show. Moody’s global speculative-grade default rate was 3 percent in August from 1.8 percent a year ago, a Sept. 10 report showed.

“Why wouldn’t you want the higher priority in a capital structure?” said DoubleLine’s Baha. “It all goes back to ‘Don’t fight the Fed,’ I suppose.’”

To contact the reporter on this story: Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story: Shannon D. Harrington at sharrington6@bloomberg.net


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Companies Mentioned

  • JPM
    (JPMorgan Chase & Co)
    • $60.45 USD
    • 0.33
    • 0.55%
  • RDNT
    (RadNet Inc)
    • $8.01 USD
    • -0.16
    • -2.0%
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