By Caroline Salas
May 30 (Bloomberg) -- The extra yield investors demand to own U.S. junk bonds instead of Treasuries fell to a record low on speculation the economy is accelerating, bolstering the ability of companies to meet their debt payments.
Risk premiums on high-yield, high-risk U.S. corporate bonds narrowed to 2.42 percentage points on average yesterday, based on Merrill Lynch & Co.'s high-yield index, which has tracked yield premiums since the end of 1996. The spread is half the average of about 5 percentage points over the past five years, and is down from more than 10 percentage points in 2002.
``You're not paid to step out on a limb,'' said Jane Caron, chief economic strategist at Dwight Asset Management in Burlington, Vermont. ``It's hard to see what would happen to make them go lower,'' she said, referring to spreads.
Dwight Asset Management oversees about $60 billion of fixed-income assets and is ``underweight'' investment-grade corporate bonds and ``neutral'' junk bonds, Caron said. Underweight means investors own a smaller percentage of the debt than is contained in benchmark indexes.
The New York-based Conference Board yesterday said its index of consumer confidence advanced to 108 in May from a revised 106.3 the previous month. The median forecast of 67 economists surveyed by Bloomberg News was for a reading of 105. The index averaged 105.9 last year.
The Federal Reserve Bank of Philadelphia on May 17 said its general economic index rose to 4.2 for May from 0.2 in April. A positive number signals expansion. The index rose as manufacturing orders and shipments increased, adding to evidence that businesses are growing more optimistic the economy will gather steam.
Rising Returns
Junk bonds are rated below Baa3 by Moody's Investors Service and BBB- by Standard & Poor's. The securities have returned 4.81 percent this year, including reinvested interest, heading for their best annual performance since 2003, Merrill data show.
High-yield bond sales total about $77 billion this year as drugstore chain Rite Aid Corp., based in Camp Hill, Pennsylvania, and automaker Ford Motor Co. of Dearborn, Michigan, sold debt, according to data compiled by Bloomberg. The record was set last year, when $148 billion was issued.
``We're in the beginning stages of the late cycle: Corporate leverage begins to rise much more in earnest from this point, which goes hand in hand with equity markets performing quite well'' and attractive junk-bond returns, said Christopher Garman, head of high-yield strategy at Merrill in New York. ``That sort of backdrop can persist for over a year.''
Yield spreads on emerging-market bonds touched a record low of 1.49 percentage points on May 22, the lowest since JPMorgan Chase & Co. introduced its EMBI Plus index in 1997.
Bernanke's Warning
Federal Reserve Chairman Ben Bernanke this month said lenders may be taking on too much risk as record amounts of leveraged buyouts fuel junk-rated debt issuance.
More than half of the junk bonds sold this year were used to pay for leveraged buyouts and mergers and acquisitions, according to a Barclays Capital report this month. About $433 billion of LBOs have been announced this year, a rate that may eclipse last year's record of $701.5 billion, according to data compiled by Bloomberg.
``I urge banks to closely evaluate the risks that they're taking, not only in a context of a highly liquid, benign financial environment, but in one that would conceivably be less liquid and less benign,'' Bernanke said at a conference on May 17. ``We do think it's very important for banks to be quite aware of the risks that are associates with working with private-equity firms.''
Junk-rated loan borrowings have totaled more than $474 billion so far in 2007, on pace to beat last year's record $687 billion, Bloomberg data show.
Like 1996
Low defaults and narrow high-yield spreads are likely to persist until at least 2008, according to Garman.
The current market parallels that of 1996, when equity markets ``started to go gangbusters'' and former Fed Chairman Alan Greenspan gave his ``irrational exuberance'' speech, Garman said. High-yield bond spreads held around 3 percentage points until 1998, when Russia defaulted on its debt and hedge fund Long Term Capital Management LP required a $3.5 billion bailout.
The global high-yield default rate was 1.5 percent in April, almost the lowest rate in a decade, according to Moody's. The rate was 1.7 percent at the end of 2006, its lowest year-end level since 1996 and its fifth straight annual decline.
Companies are taking advantage of low borrowing costs by piling on debt. The total debt for about 300 companies rated BB and B expanded by 16 percent last year, double its growth in 2005, according to Fitch Ratings.
``The ultimate end game comes when price-to-earnings multiples and corporate leverage are high,'' Garman said. ``When you have the Fed tightening into that climate, that's when the capital markets take it in the chin and default rates accelerate in earnest.''
To contact the reporter on this story: Caroline Salas in New York at csalas1@bloomberg.net
|
