By Mike Cherney
Sales of corporate bonds whose interest payments rise and fall
with market benchmarks are down nearly 40% this year, another sign
investors are skeptical after several false starts that U.S.
interest rates will rise significantly in coming years.
Food conglomerate Kraft Heinz Co., power-plant operator Exelon
Corp., regional bank Huntington Bancshares Inc. and energy firm
ConocoPhillips have canceled sales of floating-rate notes in recent
months. Roughly $71 billion of floating-rate corporate debt has
been sold this year in the U.S., down from $116 billion at this
point last year and the lowest level since 2012, according to data
provider Dealogic.
Interest payments on "floaters," as investors call them, are
generally set below fixed-rate bonds but offer protection against
rising rates by moving in tandem with the broader market.
For investors, that is potentially appealing in a year when the
Federal Reserve is expected to raise its fed funds overnight
bank-lending rate for the first time since 2006. For companies, the
bonds offer an opportunity to reduce immediate borrowing costs and
attract a wider range of investors.
But many investors say they are cautious on floating-rate debt,
given that they expect any rate increases from the Fed to be
gradual amid turmoil overseas and mixed economic data at home.
Given that rate outlook, investors say the higher yields on
fixed-rate bonds offer a better deal.
There is a "benign rate outlook that seems to have crept into
the market over the last couple of months," said Joe Lynagh, who
oversees the $577 million T. Rowe Price Ultra Short-Term Bond Fund.
"You have a lot of question marks."
Mr. Lynagh's fund is 20% invested in floating-rate debt, but he
said an allocation of 40% or 50% would be reasonable if the Fed
were expected to move aggressively on rates.
The decline in floating-rate note sales doesn't mean companies
aren't able to sell all the bonds they need. Instead, firms are
obliging investor demand for fixed rates. In the U.S., fixed-rate
corporate debt sales are roughly $945 billion so far this year, an
increase of 18% from last year and the highest level on record,
according to Dealogic data.
Wall Street economists have been predicting for years that the
Fed is poised to increase its target for the federal-funds rate,
the interest that banks pay to borrow money from each other
overnight. But the Fed has kept the rate, which broadly affects
borrowing costs for households and businesses, near zero since 2008
to keep the U.S. economic recovery on track.
Analysts now say the Fed could increase the target rate as soon
as September with the economy gaining steam, and Fed Chairwoman
Janet Yellen said in congressional testimony Wednesday that it is
likely the central bank will increase the rate later this year. But
some bond buyers believe the rate increase, if any, will be
small.
Kent White, portfolio manager and director of investment-grade
research at Thrivent Asset Management, which oversees $96 billion,
said he has been avoiding floating-rate bonds. He said a recent
bond deal from Baxalta Inc., a pharmaceutical company spun off from
Baxter International Inc., illustrates his point. The company sold
three-year debt with both fixed and floating rates. The
floating-rate bond priced to yield 1.06%, and the fixed-rate bond
priced to yield 2.02%.
"That's a lot of yield to give up unless you have a pretty
aggressive view on the Fed's tightening path," Mr. White said.
Bankers say they are still recommending floating-rate debt to
companies, given that not all investors have the same outlook on
where rates are headed. But preference for fixed-rate debt among
investors is swaying companies' decision to cancel floating-rate
portions.
Exelon said it "ultimately favored fixed-rate bonds in response
to investor demand," and ConocoPhillips said it sees "much greater
market depth for fixed-rate debt." Huntington said it sells bonds
"based on whichever rate structure provides the best pricing
outcome." Kraft Heinz declined to comment.
Still, companies also have an incentive to go fixed rate. Many
floaters have short-term maturities, meaning a company could have
to refinance its bond in a few years when rates may be
substantially higher.
A fixed-rate bond locks in the current low rates until the bonds
mature.
TCH LLC, which oversees about $12 billion and is a subsidiary of
BMO Global Asset Management, has been holding steady on its
allocation to corporate floating-rate debt, said portfolio manager
Scott Kimball. The $1.1 billion BMO TCH Core Plus Bond Fund has
about 10% to 15% of its assets in those bonds, Mr. Kimball
said.
Given the Greek debt crisis and other events overseas, the
"overall environment is supportive of stable interest rates," Mr.
Kimball said.
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