Fed’s Twist a Plus for Corporates

Federal Reserve Chairman Ben S. Bernanke's Operation Twist is paying dividends in the corporate bond market.

The central bank's program to extend the average maturity of debt in its portfolio by selling short-term bonds and buying longer-term ones is helping borrowers from McDonald's Corp. to Procter & Gamble Co. cut interest rates to record lows. Since August, the difference in yields between notes due in one to three years and bonds that mature in 15 years or more has shrunk by 0.7 percentage point to 3.3 percentage points.

Companies already flush with cash are locking in all-time low borrowing costs for decades thanks to the Fed's Twist and its bid to stimulate the world's largest economy by pledging to hold rates near zero until at least late 2014. Sales of bonds due in more than 15 years soared to $13.6 billion in January from $5.28 billion in December, according to data compiled by Bloomberg.

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"From a company standpoint, that's kind of a home run scenario," Lon Erickson, a money manager who helps oversee $9 billion of fixed-income assets for Thornburg Investment Management Inc. in Santa Fe, New Mexico, said in a telephone interview. "It's exactly what I'd be doing."

The average yield on corporate bonds in the U.S. maturing in 15 or more years was 5.138 percent as of Feb. 3, after reaching 5.005 percent on Jan. 31, the lowest on record in Bank of America Merrill Lynch index data that goes back to 1999.

That compares with a 1.822 percent average yield on company debt that matures in one to three years, the data show.

For borrowers, "it's a motivation to do a 10-year as opposed to a five-year deal," Anthony Valeri, a market strategist with LPL Financial LLC in San Diego, which oversees $330 billion, said in a telephone interview. "The trend that we've seen over two years now is for corporates to redeem some of their short-term debt and lock in attractive longer-term funding."

Elsewhere in credit markets, the extra yield investors demand to hold corporate bonds globally rather than government debentures fell last week to the lowest level in five months. The cost of protecting U.S. company debt from default declined for the fourth straight period, reaching the lowest since July. Global bond sales soared.

Petrobras Bonds

Relative yields on company bonds from the U.S. to Europe and Asia contracted 7 basis points to 227 basis points, or 2.27 percentage points, the lowest level since Sept. 2, according to Bank of America Merrill Lynch's Global Broad Market Corporate Index. Yields have fallen to 3.594 percent from 3.625 percent on Jan. 27.

The Barclays Capital Global Aggregate Corporate Index has lost 0.17 percent this month, paring its gain this year to 2.6 percent.

Petroleo Brasileiro SA's $7 billion bond sale on Feb. 1, Brazil's biggest corporate debt offering on record, led $92.6 billion of issuance worldwide last week, a 62 percent increase from $57 billion in the period ended Jan. 27, Bloomberg data show.

The Rio de Janeiro-based oil producer's $1.75 billion of 3.5 percent notes due February 2017 rose 1.2 cents from the issue price to 100.6 cents on the dollar as of Feb. 3, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Bonds of Petrobras were the most actively traded U.S. corporate securities by dealers last week, with 873 trades of $1 million or more.

Company bond sales of $404.8 billion this year compare with $412.4 billion in the corresponding period of 2011, Bloomberg data show.

The Markit CDX North America Investment Grade Index, which investors use to hedge against losses on company debt or to speculate on creditworthiness, declined 5.7 basis points last week to a mid-price of 94.5 basis points, the lowest since July 22, according to data provider CMA. The gauge has declined from 147.5 on Nov. 25.

The Markit iTraxx Europe Index of credit-default swaps linked to 125 companies with investment-grade ratings increased 5.25 basis points to 132.25, according to JPMorgan Chase & Co. at 10 a.m. in London.

The indexes typically fall as investor confidence improves and rise as it deteriorates. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a swap protecting $10 million of debt.

Leveraged Loans

Prices on leveraged loans rose for a seventh straight week, reaching the highest since August. The Standard & Poor's/LSTA U.S. Leveraged Loan 100 index added 0.34 cent to 93.4 cents on the dollar. The measure, which tracks the 100 largest dollar- denominated first-lien leveraged loans, has climbed from 90.29 on Nov. 29.

Leveraged loans and high-yield bonds are graded below Baa3 by Moody's Investors Service and lower than BBB- by S&P.

In emerging markets, relative yields tightened 22 basis points to 388 basis points, the lowest since Nov. 8, according to JPMorgan Chase & Co.'s EMBI Global index. The measure has averaged 354 in the last year.

Traders have been driving down long-term yields since before the Fed's Sept. 21 announcement that it would buy $400 billion of bonds with maturities of six to 30 years through June, while selling an equal amount of debt maturing in three years or less in a program known as Operation Twist.

Operation Twist gets its name from a policy conducted by the Fed in cooperation with the Treasury Department in 1961, when the central bank bought long-term securities as the government concentrated its issuance in shorter maturity debt.

While Fed staff called it Operation Nudge, it became known as Operation Twist, after Chubby Checker's hit, The Twist, according to a report published March 14 by Eric Swanson, an economist at the Federal Reserve Bank of San Francisco.

The central bank has kept its target interest rate at zero to 0.25 percent since December 2008 and expanded its balance sheet by purchasing $2.3 trillion in bonds. On Jan. 25, the Federal Open Market Committee said the outlook for the economy would likely warrant that rates remain near zero through at least late 2014, more than a year later than planned.

Borrowing costs for companies around the world have also been driven lower as confidence builds that Europe's sovereign debt crisis won't disrupt credit markets. The European Central Bank set off a rally in riskier assets on Dec. 21 when it gave financial institutions a record 489 billion euros ($643.4 billion) of three-year loans in a so-called longer-term refinancing operation.

'Floodgates Opened'

"It all started from that three-year lending operation," LPL's Valeri said. "That's why, with Europe getting better, the floodgates opened to start the year."

The average yield on corporate bonds worldwide is down from 4.064 percent on Dec. 21 and is at about the lowest since August, according to the Bank of America Merrill Lynch Global Broad Market Corporate Index.

That sparked $337.1 billion of company bond sales from the U.S. to Europe to Asia in January, almost double December's $183 billion total and the most since May, Bloomberg data show. Offerings in January of bonds that mature in more than 15 years were 64 percent higher than the monthly 2011 average of $8.3 billion.

P&G, the Cincinnati-based maker of Crest toothpaste and Pampers diapers, issued $1 billion of 10-year debt, paying a record-low coupon of 2.3 percent for the maturity. International Business Machines Corp., the world's biggest computer-services provider, sold $1.5 billion of notes due February 2015 at an interest rate of 0.55 percent, the lowest for three-year debt. McDonald's, the largest restaurant chain, paid a 3.7 percent coupon on its $500 million of 30-year bonds, also an all-time low.

While that level is "pretty attractive" for McDonald's, it's not as appealing for investors, Thornburg's Erickson said.

"Even if it's a good company, a lot of things can happen," he said. "There could be a lot of volatility in the meantime and I just don't know that you're getting paid for that."

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