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In Bonds, Bull Market for Firms

null|The New York Times
Thursday, 8 Mar 2012 | 4:43 AM ET

The Advance Auto Parts executives said the timing was right. The company wanted to capture more business by adding stores and expanding its fleet as motorists kept cars longer and needed more parts. So in January, looking at historically low interest rates and reassured by relative calm in the financial markets, the company issued $300 million in 10-year corporate bonds that pay investors 4.5 percent interest a year.

Money is cheap for companies with good credit, and they are piling into the corporate bond market. But what is good for borrowers may not be so good for lenders — in this case the investors buying the bonds. Rates have gone so low that some question whether they can fall any farther.

Last week, yields on investment-grade corporate bonds hit a record low, with an important Barclays index dropping to 3.266 percent on March 2, after ending 2011 at 3.737 percent. It rose slightly this week.

Rates are low largely because corporate rates are pegged to the benchmark 10-year Treasury yield, which has dropped to around 2 percent from more than 3.5 percent in early 2011. Investors in search of higher rates than Treasuries have sought the debt of high-quality companies, though their bonds carry more risk.

“The fact that yields have fallen so much in 2011 limits how much return you can get at this point in 2012,” said Jeffrey Meli, the head of credit research at Barclays. “This is the lowest yield we have ever seen in corporate bonds to start the year.”

For a bond investor, return comes in two parts: the interest received on the bond and a capital gain if the bond rises in price. Price increases are possible only if rates continue to fall.

Some investors who trade in the bonds are also wringing their hands over liquidity, which is the ability to buy and sell large quantities of bonds on short notice. Liquidity in the market has declined because big banks are holding fewer bonds as a result of concerns about new regulations looming on trading and capital reserves.

In a recent survey, banks reported to the Federal Reserve that they held $41.6 billion in corporate bonds with maturities of more than a year, less than half as much as a year ago. Before the 2008-9 financial crisis, those holdings were more than $200 billion.

A debate is continuing over whether the Dodd-Frank law’s Volcker Rule against certain types of trading by banks, and international bank capital rules, will raise costs for investors and businesses. When it comes to corporate bonds, critics of rules that would limit the amount of risky assets banks hold say that borrowing costs for companies will rise if the bonds are harder to buy and sell.

But at the same time, fund managers have noticed that since the beginning of the year — at least until this week — the stock market has rallied as insolvency fears eased over Europe, and company earnings have been good, meaning there is some confidence in their bonds, said Ryan K. Brist, head of United States high-grade credit for Western Asset Management.

Still 'Pretty Good Value'

Corporate bonds still appear to be a “pretty good value,” Mr. Brist said. “But they are more illiquid to transact in on a day-to-day basis.”

Analysts say that if the sovereign debt crisis in Europe worsens, it could weigh on the corporate bond market as investors become even more frightened by owning assets other than the safest United States government bonds.

“The liquidity dynamic is the second-most-discussed topic right now by investors,” Mr. Meli said. “The first is Europe.”

The ultracheap borrowing costs are the lowest since the creation of the Barclays Capital United States Investment Grade Bond Index in 1973. After the record low of 3.266 percent last week, the yield was 3.328 on Wednesday.

Recently, the average investment grade corporate bond spread over Treasuries was 185 basis points, or 1.85 percent, according to the Barclays index. At the end of 2011, the average spread on investment grade bonds was 2.34 percent, compared with spreads of as high as 6 percent at the peak of the financial crisis, and less than 1 percent from 2004 to mid-2007.

This year, a vast majority of bonds issued have been for investment-grade debt, about 78 percent compared with about 12 percent high-yield bonds, said Guy LeBas, the chief fixed-income strategist for Janney Montgomery Scott. He predicted bond issuance for 2012 would be slightly less than the $1.18 trillion issued last year, mostly because less debt was coming due.

The companies have included Macy’s, which in January issued $550 million worth of 10-year bonds at 3.87 percent and $250 million in 30-year bonds at 5.125 percent, and Citigroup, which in January issued its largest bond offering since 2009, $2.5 billion in five-year bonds at 4.48 percent.

Lisa Coleman, the head of the Global Investment Grade Corporate Credit Team at JPMorgan Chase, said some of its clients, including corporations and pension funds, eschewed financials more than other investors like high-net-worth individuals with greater risk tolerance.

“They are looking at yield levels and saying ‘If you can pick through and identify those banks with securities that perform well over time, that will be a powerful opportunity,’ ” Ms. Coleman said.

More companies are issuing bonds to finance coming maturities of other bonds they hold, Mr. LeBas said. Such was the case with Sprint this month, he said, which issued $2 billion in five-year bonds at a 9.125 percent coupon and eight-year bonds at 7 percent, partly to repay debt due in 2013 and 2014.

“Investors are penalizing the stock prices of companies that have a heavy bond maturity schedule,” he said. “There is big incentive to refinance that debt and retire it early and issue longer-term debt. It is becoming a trend in the high-yield markets.”

In its decision on the Advance Auto Parts’ bond, Joshua Moore, the director of investor relations, said the company was looking for fresh money to invest in the business, and to pay off some of its debt.

The last time the company, which is based in Roanoke, Va., issued 10-year bonds, in 2010, it paid 5.75 percent. The fact it can borrow for so much less now reflects the decline in market interest rates and the fact that Moody’s and Standard & Poor’s now rate the company as being investment grade, while only S.& P. thought that was the case in 2010.

As a result, investors in the 2010 bonds have done well. A bond that cost $1,000 then now is trading for more than $1,140.

Advance contends the time is right for expansion precisely because auto industry sales plunged in the credit crisis, and as a result the average age of cars on the road has risen. That is good news for those who sell parts, Mr. Moore said.

“Cars are like people,” he said. “The older you are, the more health care you need.”

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