JPmorgan gets bullish as BofA says yields entice: credit markets

JPMorgan Chase & Co. and Bank of America Corp., the two biggest U.S. underwriters of bonds, are advising investors to stick with investment-grade debt even as yields approach record lows.

JPMorgan’s Eric Beinstein, head of the New York-based bank’s top-rated investment-grade strategy team, upgraded high- grade corporate bonds to “overweight” last week from “neutral,” saying a forecasted 15 percent decline in net supply may drive relative yields tighter. Hans Mikkelsen, a credit strategist at Bank of America who recommended the debt in December, said he has “remained bullish” after yields dropped to 3.51 percent last week from 4.25 percent in November.

“While investors don’t like it, there are few alternatives,” Beinstein said in a telephone interview. Investors “need to increase their portfolios, and some of the assets they usually buy aren’t available,” he said.

The Federal Reserve’s pledge to hold interest rates at record lows through at least late 2014, or more than a year later than planned, and a European Central Bank lending program that has contained the region’s debt crisis is driving investors to seek riskier assets. Corporate bonds worldwide have returned 2.69 percent this year, compared with 0.42 percent for sovereign debt, Bank of America Merrill Lynch indexes show.

Dealer Holdings

Dealers have trimmed their holdings of corporate bonds to the lowest level in almost a decade, Fed data show, and sales of securities tied to everything from mortgages on skyscrapers to credit-card payments have dropped 58 percent since 2007. Bank of America and Citigroup Inc. are among financial companies that said they will repay rather than roll over their share of $213 billion of bonds raised during a U.S. government-backed program after credit markets froze in 2008.

While yields on U.S. investment-grade bonds are approaching the record low 3.45 percent in August, the extra yield investors are paid to hold the debt instead of Treasuries is 2.15 percentage points, about 0.5 percentage point more than the average since 1996, Bank of America Merrill Lynch index data show.

“Where can you find yield?” Mikkelsen said in an interview. “Clearly you can’t find it in Treasuries. Corporate bonds are the only place where you can find both meaningful amounts of supply and attractive yield pickup over Treasuries.”

Spreads, Swaps, Sales

Elsewhere in credit markets, the extra yield investors demand to hold corporate bonds globally rather than government debentures declined last week to the lowest level in more than five months. The cost of protecting U.S. company debt from default rose for the first time in five weeks. Global bond sales declined, while loan prices touched the highest since August.

Spreads on company bonds from the U.S. to Europe and Asia contracted five basis points to 222 basis points, or 2.22 percentage points, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. Yields fell to 3.553 percent from 3.594 percent on Feb. 3.

The Barclays Capital Global Aggregate Corporate Index has returned 0.26 percent this month, bringing the gain since year- end to 3.03 percent.

AT&T Inc., which sold $3 billion of debt on Feb. 8, led $88.5 billion of corporate bond sales worldwide last week, a 9.9 percent decline from $98.2 billion in the period ended Feb. 3, according to data compiled by Bloomberg.

AT&T Most Active

Bonds of Dallas-based AT&T were the most actively traded U.S. corporate securities by dealers last week, with 672 trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The U.S. wireless service provider’s $1 billion of 3 percent, 10-year notes rose 0.23 cent from the issue price to 100.034 cents on the dollar as of Feb. 10.

The cost of insuring against default on European government bonds fell for the first day in four after Greek lawmakers approved austerity plans to get rescue funds. The Markit iTraxx SovX Western Europe Index of credit-default swaps on 15 governments declined four basis points to 325.

Credit-default swaps typically rise as investor confidence deteriorates and fall as it improves. Contracts pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a swap protecting $10 million of debt.

Leveraged Loans

Prices on leveraged loans rose for an eighth straight week last week. The Standard & Poor’s/LSTA U.S. Leveraged Loan 100 index added 0.01 cent to 93.42 cents on the dollar. The measure, which tracks the 100 largest dollar-denominated first-lien leveraged loans, reached 93.55 on Feb. 9, the highest since Aug. 3.

Leveraged loans and high-yield bonds are graded below Baa3 by Moody’s Investors Service and lower than BBB- by S&P.

In emerging markets, relative yields declined for a fourth straight week, tightening 0.48 basis points to 387.5 basis points, according to JPMorgan’s EMBI Global index. The index has averaged 412.1 this year.

Investment-grade corporate bonds have returned 4.25 percent since Nov. 30, headed for the biggest three-month gain since the period ended August 2010, according to Bank of America Merrill Lynch’s U.S. Corporate Master index. Spreads over Treasuries have narrowed 51 basis points during the same period.

JPMorgan’s Beinstein, whose team ranked No. 1 for investment-grade strategists in Institutional Investor magazine’s annual poll, estimates spreads may tighten an additional 25 basis points this year. Barclays Plc strategists say they may decline by as much as 30.

‘Faster’ Rally

“The rally happened faster than we were expecting,” Jeffrey Meli, head of credit strategy in New York at Barclays Capital, said in an interview. “Realistic upside is about 25 to 30 basis points of further tightening, which is still substantial and nothing to look down upon.”

JPMorgan strategists, who in December said they weren’t expecting spreads to tighten until later in the year, boosted their outlook after an “overwhelming message from the investors with whom we speak of their need to buy” high-grade bonds, they said in a note Feb. 9.

Morgan Stanley strategists said Feb. 10 that investors needed to become a little pickier after the rally, saying it was recommending they scale back holdings of European debt and the credit of financial companies in the U.S. and Asia.

“There are pockets of compelling opportunities but I am not in the camp of close your eyes and buy,” said Tom Murphy, a money manager at Columbia Management in Minneapolis, who oversees $23 billion of investment-grade credit. “We’re very troubled by the behavior of investors and the massive swing in sentiment we’ve seen in the first five weeks of this year versus the last two to three months of last year.”

Bond Funds

Assets in taxable bond funds, which invest in corporate debt, increased by $230 billion last year to $2.4 trillion, according to the Investment Company Institute, a trade group in Washington.

Companies in the U.S. will issue $700 billion of new bonds in 2012, while $400 billion of debt matures, leaving a net $300 billion of new investment-grade supply, the JPMorgan strategists said in December. Net supply was an estimated $353 billion last year.

Banks reducing their balance sheets amid tightening capital requirements from regulators are retiring rather than refinancing debt sold through government-backed lending programs started after Lehman Brothers Holdings Inc. collapsed in 2008.

Citigroup Debt

Citigroup, based in New York, has said it doesn’t plan to refinance its $38 billion of debt issued under the Federal Deposit Insurance Corp.’s Temporary Liquidity Guarantee Program and coming due this year. That’s the most of any participant in the program, Bloomberg data show. Bank of America has $23.9 billion of notes guaranteed by the U.S. government maturing before the end of 2012 that it will retire with cash and other resources.

About $220 billion of government-guaranteed bank debt will mature in 2012, JPMorgan strategists said in December.

The demand for assets that pay more interest than Treasuries is allowing companies from Walt Disney Co. to Procter & Gamble Co. to borrow at record-low rates and driving down yields on even speculative-grade borrowers to 7.78 percent, 59 basis points from the record-low reached last May, Bank of America Merrill Lynch index data show.

Walt Disney sold $1 billion of five-year notes with a 1.125 percent coupon on Feb. 9, the lowest ever for debt of that maturity, Bloomberg data show. Procter & Gamble, the Cincinnati- based maker of Crest toothpaste and Pampers diapers, issued $1 billion of 10-year debt on Feb. 1 with a record-low 2.3 percent coupon. McDonald’s Corp., the largest restaurant chain, paid a 3.7 percent coupon on its $500 million of 30-year bonds on Feb. 2, also a record.

Dealer Inventories

Primary dealer holdings of corporate bonds with maturities greater than a year dropped to $43 billion in the week ended Feb. 1, the lowest since June 2002 and a 55 percent decline since May, according to Fed data compiled by Bloomberg.

“In the past, when investors decided that they wanted bonds, they were able to buy from dealers,” Bank of America’s Mikkelsen said. “Dealers have reduced their inventory significantly.”

Sales of asset-backed bonds linked to household spending plunged to $97 billion last year, down from $231 billion in 2007, Bloomberg data show. The pace of commercial-mortgage bond issuance has not rebounded since credit markets seized in 2008, with the total amount outstanding contracting to $704.7 billion from $873 billion in 2007, according to the Securities Industry Financial Markets Association.

“If you look at the history of high-grade bond yields in the last couple of years, they have continually come down,” Beinstein said. “It’s difficult to believe that there’s a line in the sand and yields can’t go lower, because they have continually done so.”