Tuesday, June 19, 2012

Should I Worry About The Corporate Bond Market?

In 2008, well before the stock market collapsed in the aftermath of the Lehman Brothers bankruptcy, the corporate debt markets were signalling trouble ahead.

Corporate spreads (i.e., the yield premium of corporate bonds relative to U.S. Treasury obligations) started to widen in early 2008 as bond buyers nervously asked for more yield concessions in order to take on new positions, and continued to gap higher right into the Lehman failure.

Ultimately the credit markets froze in October 2008, and a full-fledged credit crisis ensued. It was not until March 2009, after aggressive intervention by the Federal Reserve and the U.S. Treasury, that some sort of relative calm returned to the capital markets.

So it was with some concern that I read an article in this morning's Financial Times titled "Investors demand big yield premiums on corporate bonds".  Here's an excerpt:

Investors are demanding significant yield premiums to buy new corporate debt being sold in the U.S. as compensation for the rise in market volatility stemming from the worsening of the debt crisis in Europe.

Bankers estimate that for investment-grade bonds, investors are asking for yields that are on average 20-25 basis points higher than where existing bonds by the same issuer are trading in secondary markets.

That is the highest so-called new issue concession since the start of the year.

http://www.ft.com/intl/cms/s/0/545b558c-b94f-11e1-b4d6-00144feabdc0.html#axzz1yFvs4Ikh

The piece goes on to note that new corporate bond issuance is running at just $28 billion this month, compared to a monthly average of $88 billion, according to Dealogic.

After reading this article, I walked down the hall to talk to my friend Barbara Cummings about what's going on in the bond market.

Barbara runs the bond area here at Boston Private Bank, and is particularly knowledgeable about corporate bonds.

Barbara told me that while things are not great in the credit markets - everyone is nervous about Europe - we are not yet in conditions similar to 2008.

Apparently there are a couple of factors influencing the debt markets today.

First, investors are reluctant to give up their existing bond holdings for new issues because of today's lower rates.  They would rather hold onto an older issue with, say, a 3% coupon, rather than swap into a new issue with a coupon of 2% or less, regardless of yield-to-maturity.

And, second, current bids for older corporate bonds in the secondary market also weak.  This is the result not only of investment concerns, but also because new stricter capital requirements make banks less eager to tie up capital in low margin fixed income business.  Thus bond swaps - selling older issues for new ones - are less easily accomplished.

So I asked Barbara:

"Should I worry?"

"Oh,"Barbara replied with a smile, "you can worry about lots of things - you always do - but I wouldn't read too much into the current corporate bond markets."