Investors Turn Finicky on Corporate Bonds

High-grade corporate issuance is up, but for lower-rated firms, it has been a different story

Bond-market turbulence in 2016 is widening the gap between corporate haves and have-nots, a dynamic that threatens to weaken the U.S. economic recovery by raising financing costs for lower-rated firms.

The wealthiest companies have hardly missed a beat even as investors have retreated from risk and economic numbers have softened. Investors bought $12 billion in bonds Monday from triple-A-rated Exxon Mobil Corp., and Anheuser-Busch InBev NV andApple Inc. also have completed blockbuster deals this year.

High-grade corporate issuance during the first two months of the year is up from the same period a year ago, when highly rated firms sold the most new bonds on record for the fourth year in a row, according to Securities Industry and Financial Markets Association data.

But for lower-rated firms, it has been a different story. U.S. junk-bond issuance had its slowest start to the year since 2009, according to Dealogic, and firms that have managed to sell bonds are paying a hefty price.

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Software firm Solera Holdings Inc. on Monday sold $1.7 billion of junk bonds to finance its buyout, after reducing the sale from a planned $2 billion. The firm also increased its interest rate and made several investor-friendly covenant changes, according to S&P Global Market Intelligence.

The shift shows bond investors are getting pickier, focusing on low-risk bonds that are easy to trade. Whats in: highly rated debt from the safest issuers and bonds from companies expected to be resilient in a slower economy. Whats out: the energy sector, bonds from companies seen as needing a growing economy to thrive and bonds with longer maturities.

Were a long ways from the market being really hot, said Ryan Preclaw, a credit strategist at Barclays PLC. The more difficult deals are still going to be extremely difficult.

Access to credit plays a key role in measures of financial conditions, which the Federal Reserve looks at when deciding whether to adjust its monetary policies. William Dudley, president of the Federal Reserve Bank of New York, said Monday that a continued tightening in financial conditions could prompt him to lower his outlook for economic growth, a shift analysts said could damp Fed plans to raise interest rates this year.

Those concerns have been most evident in high-yield bond trading. The iShares iBoxx USD High Yield Corporate Bond exchange-traded fund, the largest junk-bond ETF, has rallied in recent weeks, pushing its total return for the year to 0.4% on Tuesday, its first showing in the black all year.

But the ETF dropped as much as 6.2% earlier this year, underscoring the depth of investor risk aversion at midwinter. Even following the recent rally, many bond classes within the junk category continue to trade lower, reflecting concerns about economic and market volatility.

Theres not a lot thats actually performing at the averages, saidDavid Schawel, a portfolio manager at New River Investments.

One example: Some investors are buying high-yield debt that matures in shorter amounts of time, helping lift its recent performance over comparable bonds with longer maturities. Debt maturing in one to three years has risen 0.6% this year, while bonds maturing in three to five years are down 0.8%, according to index data maintained by Markit.

Others are differentiating between companies that are seen as depending more on a strong economy boosting earnings and cash flow. During the first eight weeks of the year, $51 billion worth of bonds were downgraded to the speculative category from investment grade, the most since 2009, according to Barclays PLC.

James Keenan, global head of fundamental credit at BlackRock Inc., said he is wary of companies that could be squeezed if a weak economy pushes up their cost of capital too much.

In each sector we are seeing companies that are probably too levered toward economic growth and will be stressed in this economic environment, he said. Still, he sees some attractive opportunities in the current market environment, he said.

In some ways the broader market is affecting most companies in the same manner, particularly in the cost of borrowing. For example, the yield premium demanded by investors has risen even for Exxon Mobil. A 10-year bond issued by the company Monday paid 1.3 percentage points more than comparable Treasurys, versus 0.58 percentage point on a 10-year bond sold last year, according to S&P Global Market Intelligence.

Jeffery Elswick, a portfolio manager at Frost Investment Advisors, said he has been purchasing some low-rated bonds, but only short-term debt, such as paper issued by Sprint Corp. that matures around the turn of the year. His reasoning: If you dont know where the market is headed, why lock yourself in for a long period of time during which the economic cycle could turn or rates could rise?

Our level of certainty about the prospects of the markets is lower, he said.

Ben Eisen

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