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An appetite for junk
WHEN cash
deposits pay virtually zero, investors have an incentive to take risks in
search of higher returns. That has been good news for the high-yield, or junk,
bond market, where companies with poor credit ratings (below the
investment-grade threshold of BBB) turn for finance. Many companies can now borrow
at rates that governments would have been pleased to achieve two decades ago.
Indeed, so low have borrowing costs fallen that some wags have dubbed the
market “the asset class formerly known as high-yield”.
Until the hiatus
related to the budget crisis in America, companies were rushing to take
advantage of this financing opportunity. In the first nine months of the year
global high-yield-bond issuance reached $378.2 billion, up by 27% on the same
period in 2012, according to Dealogic, a financial-data firm. Sprint, an
American telecoms company, raised $6.5 billion in two simultaneous bond issues,
the largest-ever junk financing.
Low rates will
not last forever, so companies are keen to take advantage of what might be an
historic opportunity. And investors have been happy to take the extra yields on
offer, given the positive returns achieved since 2009.
In America, the
modern high-yield-bond market dates back to the 1980s. Until then, high-yield
bonds were usually “fallen angels”—companies which previously had an
investment-grade credit rating but had seen their finances suffer. But Michael
Milken and his team at Drexel Burnham Lambert, an investment bank, discovered
there was a market for high-yield debt from new issuers, often in connection
with companies making takeover bids.
The market is
now huge. A study by Russell, a consultancy, estimated its total size at $1.7
trillion. Almost half of all the corporate bonds rated by Standard & Poor’s
are classed as speculative, a polite term for junk. Part of this is down to
fashion; companies have been urged to return spare cash to shareholders and to
make their balance-sheets more efficient by taking advantage of the tax
deductibility of interest payments.
Another big
boost to the market has been the broadening of its base beyond America.
According to Fraser Lundie, a high-yield-bond manager at Hermes, America
comprised 89% of the market in 1998; now it forms just 57%. Europe has gone
from 3% of the market to 27%.