Corporate Debt Issuance In August Sets Record, Analysts Warn Of Junk Bonds

This month has been the busiest August on record for global corporate bond issuance as low-risk free yields on government bonds pushed investors to find better returns in corporate credit.

Corporate treasurers have issued nearly $120 billion of debt in the month to date, the Financial Times reports, citing data provider Dealogic. That's the highest August figure since its records began in 1995, and more than double the $58 billion average.

August is typically a slow month for sales of corporate bonds, but the surge in debt sales came as investment grade corporate bond yields, which move inversely to prices, are at or near record lows, providing companies with the ability to lock in long-term funding cheaply.

Central banks, including the Federal Reserve, seem determined to keep overnight rates at rock-bottom levels for a prolonged period. Low U.S. Treasury yields are a key aim of the Fed as it continues with Operation Twist until the end of the year.

The value of corporate bonds that pay fixed coupons rises as interest rates fall, so the market has been boosted by the decline in Treasury yields as the Fed continues its policy of buying large quantities of longer-dated debt, which has also forced investors to seek higher yields from corporate debt.

Although yields on the 10-year Treasury note rebounded from a record low of 1.379 percent touched on July 25, to 1.657 on Monday, it's still below the 2 percent mark. By the end of September, the 10-year note will yield 1.60 percent, according to the median estimates in a Bloomberg survey, below June's projection of 1.90 percent. The year-end forecast fell to 1.65 percent from 2.1 percent.

In Europe, comments from European Central Bank president Mario Draghi helped bolstered risk appetite, which led to a jump in corporate bond issuance from an August average of $8 billion to $12 billion. During his speech in London on July 26, Draghi said: "Within our mandate, the ECB is ready to do whatever it takes to preserve the euro," adding: "And believe me, it will be enough."

This increased risk appetite has provided some relief to big banks in the crisis-hit euro zone periphery - with both Spain's largest lender Banco Santander, S.A. (NYSE: SAN) and Italy's biggest bank UniCredit SpA (Milan: UCG) able to tap the public debt markets and become the first Spanish and Italian banks to issue bonds for several months.

Sales of corporate bonds in Asia have also been strong, up from $27 billion in August 2011 to $41 billion this month.

According recent data issued by the People's Bank of China, China's first-half corporate bond issuance reached 1.46 trillion yuan ($229.7 billion), an increase of 396.6 billion yuan, or 37 percent from a year earlier.

In the U.S., most of the increase in corporate bond issuance was concentrated in the earlier weeks. Last week saw sales plummet 79 percent as borrowers stood on the sidelines.

That said, U.S. still saw the biggest surge compared with other countries. Investor demand has enabled high-yield bond issuance to rise from an August average of $7 billion to $27 billion so far this month. The $35 billion of investment-grade bond issuance in the U.S. was also higher than the $27 billion August average.

JPMorgan Chase & Co. (NYSE: JPM), despite being rocked earlier this year by $5.8 billion in trading losses, plus a two-notch downgrade from Moody's Investors Service, led the rush on Aug. 13 with a $2.5 billion deal, followed by a $1.2 billion offering from Duke Energy Corp (NYSE: DUK).

Two days later, the rater became the rated, as Moody's Corporation (NYSE: MCO), parent of credit-rating company Moody's Investors Service, sold $500 million of 10-year bonds in only its second debt offering since 2005.

Last week, Illinois Tool Works Inc. (NYSE: ITW) sold $1.1 billion of 30-year bonds at a coupon of 3.90 percent, joining a small club of borrowers to issue long-dated bonds at lower than 4 percent, and saving nearly a full percentage point from its 30-year offering a year ago.

Companies such as Unilever N.V. (NYSE: UN), International Business Machines Corp. (NYSE: IBM),

McDonald's Corporation (NYSE: MCD) and 3M Co (NYSE: MMM) have all sold debt this year at record low yields as investor seek higher returns than Treasury yields in so-called blue-chip names.

And it's not just the high-quality companies that are benefiting from investors' hunger for returns.

So far this year, sales of corporate junk-rated debt are at the second-highest level on record.

Companies with credit ratings below investment grade, including CIT Group Inc. (NYSE: CIT), Schaeffler Technologies and United Rentals, Inc. (NYSE: URI), have sold a combined $220 billion of debt so far this year, according to Thomson Reuters data. That is slightly below the record $235 billion sold in the same period of 2011.

However, investors wanting to get into the junk-bond market should stay cautious.

Last week, Mark Kiesel, head of corporate credit for Pimco, one of the largest buyers of U.S. corporate debt, said he had reduced exposure to high-yield debt since July as prices have soared. The Newport Beach-based money manager has cut allocations to high yield in its corporate debt portfolios from about the 12 percent it usually holds, to about 8 percent.

Barclays credit strategists Bradley Rogoff, Eric Gross and Mike Kessler said in an Aug. 24 note to clients that while the activity in high-yield bond market is a welcoming development, particularly for managers with excess cash that needs to find a home, investors should remain cautious on two fronts.

First, bonds that come to market in low yield environments have historically underperformed during any subsequent selloffs.

And second, when issuance reaches very high levels, it can potentially saturate the market, causing subsequent poor performance across the board.

For every week from 2010 through 2012, Rogoff and his colleagues tally the total amount of high yield issuance and then the total return performance of the U.S. High Yield Index during the ensuing four weeks.

Weeks with less than $4 billion in issuance tend to be followed by a reasonably typical distribution of performance. However, when issuance climbs to $4 billion to $7 billion, the market's average subsequent return performance begins to deteriorate, particularly at the three- and four-week time horizons.

Following very large issuance weeks (larger than $7 billion), performance tends to be even weaker, and the apparent indigestion manifests itself more quickly, as the first two weeks on average are negative.

Given that the past three weeks have all featured more than $ 7 billion in issuance (totaling $8.9 billion, $13.3 billion, and $10.6 billion), there would normally be reason for concern regarding near-term performance.