“Buying high-quality debt alone is not going to put meat on the table, and you have to take a little more risk.’”, John Kerschner, Janus Capital Group Inc.

“Please read this short WSJ article below entitled ‘Investors Clamor for Risky Debt Offerings’. Again, the truth is being revealed. Once again, investors ‘tired of lower Fed-engineered yields on safer deals’ are ‘snapping up low-rated securities backed by companies, home mortgages, and car loans’. Investors (almost all of whom are sophisticated institutions) weren’t mislead during the last financial crisis into buying private MBS and other riskier securities (and most didn’t foresee the housing/financial bubble and bust). No one forced pre-financial crisis investors to buy these riskier assets; just like today. They made their own decisions to buy risky assets and ‘reach for yield’ to compensate for paltry Fed-engineered yields on safe assets like U.S. Treasuries and highly-rated corporate bonds. That increase in investor demand, then caused an increase in issuer supply and risk. When investor demand abruptly stopped in the Summer/Fall of 2007, the supply abruptly stopped. Investor appetite for yield/risk is the key control point.” Mike Perry, former Chairman and CEO, IndyMac Bank

Credit Markets

Investors Clamor for Risky Debt Offerings

Buyers Grab Securities With Weak Ratings, Tired of Lower Yields on Safer Deals

ByAl Yoon And Katy Burne

Risky debt is flying off the shelves.

Investors are snapping up low-rated securities backed by companies, home mortgages and car loans at a clip rarely seen since the financial crisis, as fund managers and others tire of paltry yields on safer assets.

Buyers poured $3.42 billion into taxable U.S. high-yield mutual funds and exchange-traded funds in the first quarter, outpacing the year-earlier period’s $1.76 billion total, said fund tracker Lipper, and following a full-year outflow of $4.98 billion in 2013. At the same time, robust demand for the lowest-rated portions of some asset-backed securities has enabled issuers to cut offered yields, investors said.

The actions highlight the widespread expectation that the Federal Reserve will keep interest rates low for at least another year even as the economy picks up speed. The conditions should keep defaults low, investors said, enabling purchasers of the debt to pocket returns above those from more highly rated offerings.

“The world seems a safer place than it did two years ago, or even a year ago,” said John Kerschner, global head of securitized products at Janus Capital Group Inc., which manages $174 billion. Buying high-quality debt alone is “not going to put meat on the table, and you have to take a little more risk.”

Despite the expanding economy and the quiet inflation outlook, many observers warn that hefty sales of riskier debts raise warning signs.

Fed governor Daniel Tarullo last month warned about the risks of investors’ “reach for yield” and the “incentives for these firms to take on excessive risk,” in remarks at the 30th annual National Association for Business Economics conference in Arlington, Va. He said low rates could “potentially inflate a speculative bubble.”

Freddie Mac, the government-backed home-loan financing company, on Wednesday sold $966 million of derivatives backed by mortgage loans. Demand for the Structured Agency Credit Risk notes—debt that enables private investors to shoulder more of the risk of financing the U.S. housing market—was strongest in the riskiest, unrated portion of three classes of notes sold. Investors registered $10 of orders for each dollar of so-called M3 notes sold. Holders of the M3 notes share in any losses first.

Ultimately, Freddie Mac sold $391 million of the M3 notes at a yield of 3.75%, which is 0.4 percentage point below the rate at which the company initially shopped the debt, investors said.

“We’re in an environment where the discerning eye of real credit investors has given in to the less discerning generic yield grab,” said Stuart Lippman, a portfolio manager at TIG Advisors LLC, which manages $1.8 billion and bought some of the riskiest Freddie Mac notes. Mr. Lippman said the firm is comfortable with the risk and the debt is easily traded.

The demand “is a combination of a good market…as well as a growing understanding and investor base” in the program, said Mike Reynolds, a director of portfolio management at Freddie Mac.

Security National Automotive Acceptance Co., a subprime auto lender that finances active-duty military borrowers, cut yields on the junk-rated slice of a $210 million asset-backed bond by 0.25 percentage point Tuesday after recording seven times the necessary orders, investors said.

Security National, majority-owned by private-equity giant Fortress Investment Group LLC, ultimately sold the bonds at 3.5 percentage points above an interest-rate benchmark, or 4.624%. That compares with a four-point spread for a similar deal a year ago. Security National didn’t return calls seeking comment.

About 55% of single-B-rated junk bonds in the U.S. this year priced at the low end of their targeted yield range, suggesting heavy buyer demand, according to S&P Capital IQ Leveraged Commentary & Data. That compares to 34.8% for all single-B deals in 2013.

Canadian aircraft maker Bombardier Inc. sold double-B-rated junk bonds this week that priced with yields at the low end of where they were marketed, said Bank of America Merrill Lynch, which led the two-part, $1.8 billion offering. The company didn’t respond to requests for comment.

Yield premiums on triple-C-rated bonds, one of the lowest rungs of the speculative-grade ratings ladder, are now 5.4 percentage points over comparable Treasurys, their lowest since July 2007, Barclays data show.

But strong demand also has led to some loosening of underwriting standards and covenants that afford buyers protection, investors said.

Companies have issued $1.9 billion of junk bonds that give issuers the ability to pay in additional debt rather than in cash, up from $1.2 billion in the prior year period.

In 2013, the total volume of these pay-in-kind, or PIK, deals was $12 billion, the most since 2008.

A London subway train is built at a Bombardier Inc. factory in the U.K. The Canadian company sold junk bonds this week that priced at the high end of expectations. Bloomberg News

The Moody’s Investors Service covenant-quality index, which rates high-yield bonds for investor protections, with 1 the highest score and 5 the lowest, fell to 4.14 in March from 4.05 in February.

But many observers say they don’t believe the market has grown frothy.

Angel Oak Capital Advisors this year has narrowed its purchases of commercial-mortgage-bond issues to the investment-grade debt, cutting out the junk-rated pieces as underwriters increase the amount of debt on properties, said Kin Lee, a portfolio manager at the firm.

But he still favors the lowest-investment-grade issues, because underwriting is “not anywhere” near where it was at the peak of the market in 2007, he said.

—Nick Timiraos contributed to this article.

Posted on April 7, 2014, in Postings. Bookmark the permalink. Leave a comment.

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