Junk Bonds Sell as Investors Get Bolder
By ROMY VARGHESE and MICHAEL ANEIRO
A key measure of risk reached its lowest level since last fall as investors snapped up the biggest junk-bond issue of the year, further signs companies can now borrow to meet their cash needs but still have to pay above-normal rates.
Confidence that the economy is on the verge of recovery and optimism that bank stress-test results this week will be better than initially feared helped drive investors away from the safety of Treasury debt into corporate bonds and securities backed by consumer loans.
The cost of borrowing dollars for three months, indicated by the London interbank offered rate, fell below 1% Tuesday, signaling banks are charging one another less to borrow ahead of the test results due to be released by the U.S. on Thursday. This helped narrow the gap between risk-free borrowing at the fed-funds rate and three-month Libor to 0.77 percentage point, the lowest in about eight months.
Demand for junk bonds enticed speculative-grade companies to launch $5.5 billion of offerings. Canadian mining company Teck Resources Ltd. sold $4.23 billion of debt, the biggest junk deal since last September. Nalco Co., which provides water-treatment applications, and packaging products supplier Crown Americas, a subsidiary of Crown Holdings Inc., also launched sales.
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Optimistic remarks on the economy Tuesday from Federal Reserve Chairman Ben Bernanke, shown arriving to testify, helped to support what had already been a revival of the credit markets. A key measure of risk reached its lowest level since last fall.
"A few months ago, you couldn't give a bond away," said Mitch Stapley, chief fixed-income officer for Fifth Third Bank in Grand Rapids, Mich. "But now signs are coming into place that things are looking better, there becomes a scramble to get that credit exposure."
Credit markets are extending a rally that took hold in April -- tracking gains in stock markets -- as investors became more confident banks were recovering from the recent market turmoil and the housing market was showing signs of having hit a bottom. The reduction in Libor indicates liquidity is returning to the financial system, and the ability of companies to sell debt shows they can finance themselves, albeit at higher rates.
Momentum gathered in deals eligible for a federal program to boost consumer lending, and Bank of New York Mellon sold bonds without government backing.
Companies increased offerings under the Term Asset-Backed Securities Loan Facility to more than $13.5 billion. General Electric Co. sold a $1 billion credit-card-loan-backed deal and student lender Sallie Mae sold $2.59 billion of bonds.
"Junk" bonds gained 13.3% in the second quarter through Tuesday, according to the Merrill Lynch Master II High Yield Index. Leveraged loans have become more attractive as well. Based on the benchmark Standard & Poor's LCD index, leveraged loans are valued at 71.6 cents on the dollar, the highest reading since November.
Fear of missing out on the rally pushed some investors to increase their holdings of various kinds of debt, said Michael Kastner, head of fixed-income at Sterling Stamos Capital Management in New York.
"There is so much cash sitting on the sidelines," Mr. Kastner said, adding that some investors had fallen behind in performance because they had waited so long.
"They've increased allocations across the board" toward riskier assets, he said.
In addition, relatively upbeat remarks from Federal Reserve Chairman Ben Bernanke helped boost investors' appetite. Mr. Bernanke told a congressional committee Tuesday the U.S. recession appears to be losing steam, with growth likely to resume later this year on the back of firmer household spending, a bottoming housing market and an end to inventory liquidation.
But Mr. Bernanke said the recovery will probably be slower than usual, and warned the unemployment rate may stay high "for a time" as businesses remain cautious about new hiring.
Indeed, some warn the rally in credit is overdone, and the stress tests fail to adequately solve the problem of banks loaded with toxic assets.
Companies with weak credit profiles are particularly vulnerable to the economic turmoil.
"There is a looming default cycle that is yet to be reckoned with," said CreditSights' analyst Louise Purtle in a report. She added investors should brace for volatility in returns.
While high-yield risk premiums have fallen to 13.23 percentage points over Treasurys, from 17.84 percentage points at the beginning of 2009, they are still more than double where they were a year ago.
Still, the spurt in issuance of TALF-eligible deals and the subsequent increases in size of these bonds are signs investors have finally warmed up to the Fed's consumer-lending program after a lukewarm response in the first two months of operation.
J.P. Morgan Chase & Co. Chairman James Dimon said Tuesday the TALF program, which enables companies to sell bonds backed by consumer loans, appears to be helping drive down interest rates on credit cards and student loans.
Bank of New York Mellon sold $1.5 billion in five- and 10-year nonguaranteed bank bonds. The deal was a "blowout," having received over $8 billion in orders in just two hours, according to syndicate participants familiar with the deal.
Royal Bank of Scotland sold $7 billion in a two-part offering of Federal Deposit Insurance Corp.-backed bonds. The deal included three-year floating- and fixed-rate tranches.
Risk-free but low-yielding Treasurys proved unpopular, with prices dropping on most maturities. The yield on the 10-year Treasury rose to 3.2%.
—Anusha Shrivastava and Kellie Geressy contributed to this article.
Write to Romy Varghese at romy.varghese@dowjones.com and Michael Aneiro at michael.aneiro@dowjones.com
Printed in The Wall Street Journal, page C5
