Are companies being overcharged for bond issues?
Is the corporate sector going to hell in a handcart – or has the bond market misjudged the risk of default? Unless business goes bust en masse, bonds yielding 10 per cent look a good buy and a bad sell.
The corporate bond index* currently yields 5 per cent more than government bonds at well over 9 per cent with many blue-chip companies’ paper paying double-digit returns.
That’s partly because low interest rates have left Treasury stock yielding even less than shares. But it does suggest a very gloomy expectation of corporate collapses.
The default rate on even speculative-grade debt has risen above 10 per cent only twice since the early 1970s, and only just. Legal & General reckons that if history is repeated, 15 per cent of bonds currently rated investment grade might be downgraded to junk. Even in the last recession, the cumulative defaults over a five-year period for investment-grade bonds was only 2.4 per cent, so just six months’ of today’s yield premium would compensate for five years’ of losses.
Some industries are more vulnerable than others, of course: better to be in utilities than commodities or banks at the moment, for instance. But it does seem that the companies rushing to issue bonds in recent months have been overcharged by the market.
Legal & General is quietly telling clients “corporate bonds are the asset class of choice at the start of 2009”, claiming it is a long-term investment opportunity not seen since the 1930s.
Not everyone agrees. L&G’s own regulator has just forced the company to put up £650m more capital in case defaults on bonds increase, but if it is right, then yields will fall back towards gilt levels and companies thinking of raising cash in this market would be best to wait.
* The corporate bond index is now produced by Barclays. Until last autumn it was the Lehman Brothers index. Don’t say they don’t know about defaults.
