January 8, 2016 / 9:20 PM / in 2 years

In hunt for safety, bond investors lower sights to BBB

NEW YORK, Jan 8 (IFR) - Investors piled into Triple B rated bonds in the first week of 2016, seeing value in a rating band whose spreads widened more than any other in the investment-grade spectrum last year.

Although BBB issuers sit on the cusp of junk territory, they are actually seen as less likely to be downgraded than higher-rated Single As - and thus in many ways a safer bet.

Because companies want to stay out of high-yield, where funding costs are significantly higher, BBB issuers are seen as highly motivated to maintain their credit standing.

While that may seem counter-intuitive - lower-rated credits are lower rated for a reason, and plenty in the market are still happy to say so - BBB debt clearly has some current appeal.

“For clients who are buying Single As, we are persuading them to buy Triple Bs,” one asset manager told IFR.

“They are likely in aggregate to be more disciplined, because they don’t want to go to high yield.”

In contrast, many higher-rated credits have in the past few years happily sacrificed rating notches in order to leverage up for acquisitions or shareholder-friendly actions.

While that made sense for companies looking at cheap funding costs, the downgrades affected their debt - and led to losses for the investors who own it.

“If Single As go to Triple Bs there’s no real impact on them, they just have to offer a few more basis points,” said the asset manager.

And that is leading many in the market to favor the BBB space.

“(We’re recommending) to wait for the BBB big issuers to come and to take advantage of that as opposed to trying to move into Single As and run the risk of that company deciding to leverage up and merge,” said Robert Persons, a portfolio manager at MFS Investment Management.

VALUE FOR MONEY

According to the Bank of America Merrill Lynch Master Index, BBB bonds widened an average of 43bp in 2015 - more than other bands of high-grade bonds.

That performance has made the sector appealing to investors, who scooped up bonds from a number of BBB issuers this week: Barclays, Citigroup, Boston Properties, Kroger, Black Hills, Santander UK, American Tower and Ford Motor Credit.

All tightened spreads on the back of huge orders for their bonds, a sharp contrast to the struggling high-yield market, which has publicly priced just one deal in about a month.

Barclays said in a report Friday that the spread ratio of industrial BBB to Single A bonds was roughly 1.95 times - a level at which it said Triple B credit has historically strongly outperformed.

“Long-dated BBB bonds are trading at the widest levels of the past 12 years (excluding the crisis period), especially relative to Single As,” the report said.

“They should outperform in a tightening environment.”

RISKS REMAIN

But not everyone is convinced, and skeptics point out that risks remain for credits that are just one rating action away from becoming a fallen angel.

“To buy Triple Bs under the pretext that they’re cheap and have already priced in the risk, I think is simplistic at the least and dangerous at the worst,” said Mark Howard, credit strategist at BNP Paribas.

Howard said that the lower end of the credit spectrum tended to underperform in times of economic instability or a slowdown.

And this week’s stock plunge showed that there is still plenty of volatility to go around.

Jeffrey Rosenkranz, head of taxable fixed income at Cedar Ridge Partners, cited restaurant giant Yum Brands as proof that Triple Bs were not immune to downgrades.

Yum, which owns KFC and Taco Bell, was downgraded to junk after it announced the spin-off of its China business - and Rosenkranz cautioned that credit stories still matter.

“I think you’re deluding yourself to think (if) you’re buying Triple B, you’re less susceptible to the risk,” he told IFR.

“(Risk) is company-specific and management team-specific.” (Reporting by Hillary Flynn; Editing by Shankar Ramakrishnan and Marc Carnegie)

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