Is Corporate Behavior Too Bubblicious in Bond Market?
In the fourth quarter alone, companies have announced nearly $35 billion in special dividends, some of that funded by debt.
Yet, many corporate debt strategists say the signs of a bubble are just not there, based on the healthiness of the borrowers’ balance sheets and the fact that there is huge appetite for the paper in a low yield environment. Strategists, however, do say the quality of debt issuance has peaked, as more companies are using debt for mergers and financial gymnastics in a low growth environment.
“With each deal they seem to be kicking up leverage,” said Bill Eastwood, trader and managing director at Newfleet Asset Management. “At the end of the day, are we happy to see that as creditors? Absolutely not, but as long as it’s not agregious and aggressive and as long as we are comfortable with the business then we are okay with it.”
While companies have raised debt to fund dividends and buybacks in the past, there is a much larger than normal rush to sprinkle shareholders with large special dividends before the likely tax law change at year end. The likeliest candidates have been those with large insider ownership, lots of cash, or private equity investors looking for a payout.
With the bond market wide open for business, some strategists expect to see more companies using the debt market to appease shareholder activists. For instance, Ingersoll Rand this week said it would spin off its security business and raise debt to fund a $2 billion share buyback. The company was under pressure from Nelson Peltz. After the announcement, Moody‘s said it would review the company’s ratings for downgrade.
“Not only are yields low, but the covenants are pretty lenient,” said Jack Ablin, CIO of BMO Private Bank, of the recent batch of corporate deals. “It certainly was a bubble we saw several years ago. I think we’re probably creating a credit bubble again, but that’s by design.” Ablin said the Fed is trying to encourage activity with its near zero interest rates policy. (Read More: Fed Action Risks Inflation, Veers Into Fiscal Policy: Lacker)
Corporate bond bubble fears continue to grow
Investors have been piling into corporate bonds for the past few years in search of yield at a time when haven government bond yields are at record lows, igniting concerns that the surge in demand could tip the asset class into bubble territory.
Opinion differs sharply among investors on both sides of the Atlantic. Some believe corporate bonds are already in bubble territory, while others say they still have some way to go and that the fears are greatly exaggerated.
Charlie Kerr, head of fixed income at London-based Newscape Capital, believes the shine has disappeared from corporate bonds after several years of good performance, with yields now so low that investors are no longer compensated for the risk of default.
“We sold everything we had in corporate bonds last month and are sitting on lots of cash for now,” Mr Kerr says. He believes corporate bonds are fully priced and does not expect to see “any significant move higher”. “For now we don’t think it’s a good time to get back in,” he adds….
Yelling ‘Fundamentals’ In A Crowded ‘Corporate Bond Market’
Thanks in large part to the supply-constructing yield-compressing repression of a few ‘apparently well meaning’ bad men running the central banks of the world, the divergence between fundamental weakness and credit spread ‘strength’ is at record levels. The overwhelming ‘technical’ flow of funds from investors combined with an ‘end of equity’ cult and belief that tail-risks have been removed (OMT) juxtaposes with earnings crumbling, ratings downgrades, and the exogenous fact that a complex system means a systemic crisis is inevitable (especially after such ongoing volatility suppression). As Citi’s Matt King notes, while “it is almost impossible to predict exactly when they start,” the desperation for yield has led to highly unstable equilibria – as what investors can’t earn they will lever; via lower-quality ‘levered’ assets (PIKs and BB/CCCs for example) or ‘levered’ vehicles (CLOs and structured credit). Sure enough, margins (street repo haircuts are low and NYSE margin accounts high) look very 2007-like. While yelling ‘fire’ in a crowded theater will typically get the people moving, it seems the movie that is playing in corporate credit is simply too engrossing for many to listen.
Central-Bank repression and investors’ demand for some safety has crushed the yields of the most liquid sovereign bond markets…
During the 2008 credit crisis, corporate bonds prices dropped by 30%
Moody’s Credit Rating Service just announced the ominous trend that credit quality in the municipal bond market is falling at the fastest rate since the collapse of Lehman Brothers in 2008. Data released showed that 5.3 times as many municipal bonds were credit downgraded over the three last months than were upgraded. Moody’s emphasized that: “Downgrades dominated rating revisions across all public finance sectors except for healthcare,” said Assistant Vice President-Analyst Dan Steed, author of the report. “A rapid deterioration in credit metrics led to a higher-than-average 14 multi-notch downgrades.” Often sold to individuals as “conservative investments with tax free income”, munis in states like California, Illinois, New Jersey, and Pennsylvania are increasingly looking like high risk rolls of the dice.
This credit implosion comes after a sustained period when muni bonds were performing much better than corporate bonds. During the credit crisis; corporate bonds prices dropped by 30%, while muni bonds suffered very modest losses. …
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