Tags: Bond | Rout | Odds | treasurys

Bond-Rout Odds Seen Rising as Record Inflows Ebb

Thursday, 19 April 2012 12:48 PM

Individual investors, who hold more sway over the corporate bond market than ever, are allocating the least amount of cash this year to U.S. high-yield mutual funds in a signal that sentiment may be shifting.

Speculative-grade bond funds reported net inflows of $75 million through April 16, the lowest since a monthly outflow of $9.1 million in December, according to EPFR Global data. U.S. mutual funds reported an unprecedented $698.3 billion of corporate bond assets at the end of February, from $327.9 billion in 2008, data compiled by the Investment Company Institute show.

Consumers have seized unprecedented control of the market for company debt as Federal Reserve data show ownership falling to almost a 10-year low and as trading as a portion of total bonds outstanding declines worldwide. Concern is mounting that a reversal of the stampede into the securities would undermine a market that’s gained 54 percent since the end of 2008, Bank of America Merrill Lynch index data show.

“You just have to pray the funds’ investors never want to sell all at once,” said Matt King, global head of credit strategy at Citigroup Inc. in London. “You’ve got the classic combination of promised instant liquidity and illiquid underlying assets.”

The volume of junk-bond inflows is falling from a peak of $5.5 billion in February, with investors funneling less than half of that into funds the following month, EPFR data show. Speculative-grade bonds have gained 0.08 percent this month after advancing 5.1 percent this year through March 31, according to Bank of America Merrill Lynch index data.

Heightened Nervousness

“In the last week or so I’ve sensed a higher degree of nervousness in the market,” said Bonnie Baha, head of the global developed credit group at DoubleLine Capital LP in Los Angeles, where she helps oversee $32 billion.

While global debt issuance has soared since the 2008 financial crisis as companies reacted to the withdrawal of bank credit by rushing to issue bonds, proportional trading volumes have dwindled. Bond sales peaked at $3.9 trillion globally in 2009, an increase of $1.1 trillion from the previous year, and have held at about $3.2 trillion annually since then, data compiled by Bloomberg show.

Securities equivalent to about 96 percent of the outstanding market are traded in the U.S. every 12 months, down from about 180 percent at the peak in 2005, Citigroup data show.

Chesapeake Bonds Fall

Elsewhere in credit markets, Chesapeake Energy Corp. bonds fell as the second-largest U.S. gas producer said its chief executive officer has been using stakes in wells as collateral for personal loans. JPMorgan Chase & Co. sold about $1 billion of commercial-mortgage bonds after widening the relative yields on some classes. Formula One, the auto-racing series owned by CVC Capital Partners Ltd., cut the interest margin it will pay for a $1.38 billion loan refinancing.

The U.S. two-year interest-rate swap spread, a measure of debt market stress, increased 0.44 basis point to 29.19 basis points. The gauge, which has expanded from a more than seven- month low of 23.5 on March 28, widens when investors seek the perceived safety of government securities and narrows when they favor assets such as corporate bonds.

The cost of protecting company bonds from default in the U.S. rose for the first time in three days, with the Markit CDX North America Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, climbing 0.9 basis point to a mid-price of 99.4 basis points, according to Markit Group Ltd. The index has climbed from a one- year low of 85.4 on March 19.

Credit Swaps Climb

In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings increased 6.6 to 142.8.

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

Chesapeake bonds were the most actively traded U.S. corporate securities by dealers yesterday, with 199 trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The company’s $1.3 billion of 6.775 percent notes due March 2019 fell 1.875 cents to 97.125 cents on the dollar to yield 7.3 percent, Trace data show.

Chesapeake and its investors aren’t at risk from CEO Aubrey McClendon’s 2.5 percent stakes in wells being used as collateral because the Oklahoma City-based company has an overriding claim to the oil and gas that flows from them, General Counsel Henry J. Hood said.

Commercial Mortgage Bonds

A top-ranked slice of JPMorgan’s commercial-mortgage bond offering maturing in 9.91 years, initially marketed to yield 110 basis points more than the benchmark swap rate, paid 115 basis points over the benchmark, according to people familiar with the transaction. The spread on debt rated A3 by Moody’s Investors Service yields 425 basis points after being marketed to pay 400 basis points, they said.

The Standard & Poor’s/LSTA U.S. Leveraged Loan 100 index rose 0.06 cent to 93.48 cents on the dollar. The measure, which tracks the 100 largest dollar-denominated first-lien leveraged loans, has returned 4.43 percent this year.

Leveraged loans and high-yield bonds are rated below Baa3 by Moody’s and lower than BBB- by S&P.

Formula One Loan

The rate on Formula One’s loan was reduced to 450 basis points from 500 basis points more than the London interbank offered rate after lenders offered more cash than the company sought, a person with knowledge of the situation said. The debt will be sold at 99 cents on the dollar, the person said, who declined to be identified because the terms are private.

The term loan maturing in 2017 is part of $2.27 billion in new credit facilities Formula One is putting in place to replace the existing $2.92 billion in loans due in 2013 and 2014, according to S&P, which rates the senior secured loans BB-.

In emerging markets, relative yields widened 4 basis points to 360 basis points, or 3.6 percentage points, according to JPMorgan’s EMBI Global index. The measure has averaged 374 basis points this year.

Bond trading has become more difficult because investment banks won’t commit so much capital to hold the securities on their books as regulations on risk-taking loom and financial companies remain concerned that Europe’s sovereign-debt crisis may escalate.

Dealers Reduce Holdings

Dealers that are authorized to buy Treasuries directly from the government have reduced corporate debt holdings to $45.6 billion from the $235 billion they held at the peak in October 2007, according to Fed data compiled by Bloomberg.

“The quickest way to create liquidity when you have these outflows is to sell what you can,” not necessarily what you want to, Baha said. “If everyone heads for the exits at the same time, given the poor liquidity that we’re already seeing in the market, you’re going to see some incredibly volatile pricing moves.”

Holdings dropped to $40.4 billion on Feb. 22, the lowest since June 2002, according to the data.

“Each and every investment bank has significantly reduced the capital it’s prepared to commit to taking risk in recent years,” said Constantinos Antoniades, the founder of Vega-Chi Ltd. in London, which operates an electronic trading system for high-yield and convertible bonds.

Liquidity Drops ‘Dramatically’

Credit markets can freeze and prices plunge, as happened in 2008. From the end of August to Dec. 15, the Barclays Capital High Yield Market Value index plunged 44 percent, before starting to rally at the end of that year.

“Liquidity, even for the biggest clients, has dropped dramatically,” said Peter Tchir, founder of TF Market Advisors in New York.

The trend of volume ebbing is global. In euro- and pound- denominated debt, 12-monthly turnover has slipped to about 40 percent of the market from as much as 120 percent in 2004, according to New York-based Citigroup.

As trading volumes decline, there are few signs that buyside firms and brokerages can swiftly replace the volume that large Wall Street banks have withdrawn from the market.

“One way to ensure there is liquidity in the market and there is no risk of a shut-down at times of market stress, is to reduce reliance on investment bank dealer desks,” Antoniades said.

Agency brokers, dealers that seek to match buyers and sellers of securities without holding them on their own books, as well as independent electronic platforms that allow clients to enter buy and sell orders without going through an intermediary are trying to gain ground.

Replacing Market Makers

Over time, electronic trading systems, combined with clearinghouses for credit derivatives and new instruments such as exchange-traded funds that track bond indexes, will help replace the market makers, according to Tchir

BlackRock Inc., the world’s largest money manager, said April 12 it plans to start a bond-trading system that will help investors to bypass investment banks. The firm, which hopes to attract institutional investors including sovereign wealth funds and insurers to the platform.

For now, fund managers are taking preemptive measures to address shrinking secondary market volumes.

Because it is hard to trade, managers hold on to cash to meet redemptions to avoid having to sell into a rout, said Ashish Shah, who helps oversee about $420 billion as head of global credit investments at AllianceBernstein LP in New York.

The possibility that the market might seize is “a legitimate concern but portfolio managers have that concern and manage with that in mind,” he said in a telephone interview.

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Thursday, 19 April 2012 12:48 PM
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