A Federal Reserve governor is joining those warning that junk-debt investors are poised for losses, while his institution’s policies spur them to keep buying the debt.
Yields on a record 38 percent of the $1.1 trillion of notes sold by the neediest U.S. borrowers were trading below the 10- year average rate for investment-grade debentures last month, Barclays Plc data show. Investors poured a record $1.3 billion into U.S. leveraged loan funds last week as covenants on the debt weaken the most ever.
The central bank’s policy of keeping benchmark borrowing costs at about zero for a fifth year is pushing investors into riskier debt, even as Fed Governor Jeremy Stein warns that the market for speculative-grade debt may be overheating. While U.S. prosecutors are suing Standard & Poor’s for deliberately failing to provide warnings against losses on collateralized debt obligations before the credit crisis, the government’s stimulus is fueling demand for similar products now.
“No matter how loud the chorus gets that this is crazy, the bulls are going to continue to run because there’s nowhere else to put money in fixed income,” said David Tawil, the co- founder of Maglan Capital LP, a distressed-debt hedge fund that manages about $50 million. “If I’m saying now that the deals are getting laughable, if things don’t change, six months from now the deals are going to be stupid.”
Sales of so-called covenant-lite loans represented about 55 percent of the debt sold to non-bank lenders in January, the greatest proportion ever, Morgan Stanley analysts wrote in a Jan. 25 report. Covenant-lite debt does not carry lender protection such as financial maintenance requirements.
Firms from Credit Suisse Group AG to Symphony Asset Management LLC sold $8.7 billion of collateralized loan obligations in January, the busiest month of issuance since November 2007, according to JPMorgan Chase & Co. CLOs pool high- yield, high-risk loans and slice them into securities of varying risk and return.
Borrowers are selling speculative-grade bonds that have the weakest covenants in at least two years, according to Moody’s Investors Service. About $506 billion of dollar-denominated junk bonds are trading above the price that their issuers may buy them back at later, limiting potential gains, Morgan Stanley data show.
“Valuations are rich,” said Morgan Stanley credit strategist Adam Richmond in New York. “The pendulum is swinging in favor of issuers. It does seem like the peak in credit quality is probably behind us.”