C&B Notes

Welcome Back to 2007

Artificially low rates have many spillover effects, including encouraging debt buyers to both accept more risk and pay higher prices.  Even the folks peddling the products have concerns about valuations.

Investors are snapping up low-rated securities backed by companies, home mortgages and car loans at a clip rarely seen since the financial crisis, as fund managers and others tire of paltry yields on safer assets…  At the same time, robust demand for the lowest-rated portions of some asset-backed securities has enabled issuers to cut offered yields, investors said.  The actions highlight the widespread expectation that the Federal Reserve will keep interest rates low for at least another year even as the economy picks up speed.  The conditions should keep defaults low, investors said, enabling purchasers of the debt to pocket returns above those from more highly rated offerings.


Freddie Mac, the government-backed home-loan financing company, on Wednesday sold $966 million of derivatives backed by mortgage loans.  Demand for the Structured Agency Credit Risk notes — debt that enables private investors to shoulder more of the risk of financing the U.S. housing market — was strongest in the riskiest, unrated portion of three classes of notes sold. Investors registered $10 of orders for each dollar of so-called M3 notes sold.  Holders of the M3 notes share in any losses first.  Ultimately, Freddie Mac sold $391 million of the M3 notes at a yield of 3.75%, which is 0.4 percentage point below the rate at which the company initially shopped the debt, investors said.

“We’re in an environment where the discerning eye of real credit investors has given in to the less discerning generic yield grab,” said Stuart Lippman, a portfolio manager at TIG Advisors LLC, which manages $1.8 billion and bought some of the riskiest Freddie Mac notes.  Mr. Lippman said the firm is comfortable with the risk and the debt is easily traded.


Yield premiums on triple-C-rated bonds, one of the lowest rungs of the speculative-grade ratings ladder, are now 5.4 percentage points over comparable Treasurys, their lowest since July 2007,  Barclays data show.  But strong demand also has led to some loosening of underwriting standards and covenants that afford buyers protection, investors said.  Companies have issued $1.9 billion of junk bonds that give issuers the ability to pay in additional debt rather than in cash, up from $1.2 billion in the prior year period. In 2013, the total volume of these pay-in-kind, or PIK, deals was $12 billion, the most since 2008.