The Economy

Corporate Bond Selloff May Be Overblown

Institutional investor appetite for corporate credit will bounce back, says one asset manager, leading spreads to tighten some once again.
Vincent RyanJuly 10, 2013

Although corporate bond issuance slowed to a crawl in June, companies don’t have to throw out their plans to finance their next share buyback, dividend or acquisition. According to bond-market experts, higher corporate bond spreads may tighten again after a major disruption in June, and higher total yields may actually wind up helping the corporate issuance market. 

New bond issuance (investment-and speculative-grade) in the United States fell to $45 billion last month, the lowest total since December 2011, after averaging $92 billion per month from January to May of this year. Global sales of new corporate bonds also shrank in June, to $144 billion from a monthly average of $316 billion, according to a report released Tuesday by Diane Vazza, managing director of Standard & Poor’s.

The culprit, of course, was the financial-market turmoil started by Federal Reserve Board Chair Ben Bernanke. Bernanke signaled the possibility of an end to the Fed’s bond-buying program by the close of 2013. The program has injected tons of liquidity into the financial markets and kept credit prices at historic lows. (Minutes of the Federal Reserve Board’s June meeting, released Wednesday, showed significant division among Fed officials on the timing of the program’s wind-down.)

But Bernanke’s statement rattled buyers of corporate investment-grade debt, says Jesse Fogarty, managing director of Cutwater Asset Management. “A lot of traditional corporate buyers got spooked by the volatility in rates,” Fogarty says. The velocity of the rate increase, for example, caused some retail investors to quickly shed long-duration bonds to prepare for a large move toward higher overall interest rates.

Particularly alarming to some bond investors was that both spreads on corporate bonds and Treasury rates increased; usually they are inversely correlated. “During the initial selloff in June, the credit markets got pretty sloppy,” Fogarty says. While yields on Treasury bonds were jumping, option-adjusted bonds spreads for investment-grade debt also rose, to 191 basis points at the end of June, up from 178 basis points a month earlier, according to S&P. Speculative-grade spreads increased to 521 basis points in June from 467 basis points in May.

Spreads over Treasuries usually widen when investors perceive higher risk in corporate credit, but that’s not the case this time. Fogarty expects them to tighten some again. One reason: higher bond yields, especially of investment-grade debt, will attract traditional long-term holders, such as insurance companies and pension funds. “Higher yields are still like water in the desert,” says Fogarty. Pension funds in particular will need to match their long-term liabilities with the higher-yielding debt, he says.

Still, with higher Treasury rates, issuing a bond will be more expensive if the total all-in cost is considered. Some companies are already looking to convertible bonds, which offer investors a lower yield but the prospect of capitalizing on appreciation of the issuer’s equity. New convertible-bond issuance in the first half of 2013 hit $50 billion, on pace to beat new bond sales totals for every year since 2008, according to S&P.