The junk bond underwriters of Wall Street are selling the debt at record speed after the securities gave a return of 19 percent last year. The issue? The Wall Street underwriters selling the products are quite sure the securities will drop as the interest rate has risen.
“Our job first and foremost is to properly structure deals for companies that can support their debt and perform well,” said Craig Packer, the New York-based head of Americas leveraged finance for Goldman Sachs Group, Inc. (NYSE:GS) “The interest-rate risk is just a law of nature.”
Big banks like JPMorgan Chase & Co. (NYSE:JPM), Deutsche Bank AG (NYSE:DB) (ETR:DBK), Citigroup Inc. (NYSE:C) and Bank of America Corp (NYSE:BAC) are gaining from the growth in a market where average underwriting fee is almost three times as big as selling more creditworthy bonds.
This year, so far, total high-yield debt underwritten by the banks stands at $89.6 billion, an increase of 36 percent from the corresponding period in 2012, as per the data of Bloomberg. According to this data, last year’s $433 billion sales was the highest in the asset class and produced around $6 billion in fees. Investors invested about $33 billion into mutual funds and exchange-traded funds, which were dedicated to junk bonds last year, an increase of 55 percent from 2011 as per Morningstar Inc.
Wall Street firms are once again selling debt that is expected to lose their value. These firms have spent a greater of $93 billion to cover the cost from the 2008 credit crisis, including lawsuits and fines for misguiding the investors about mortgage backed products.
What poses a risk to investors is not the bond’s creditworthiness, but the benchmark government borrowing rate that is poised to rise after declining to a three decade low.
The Fed has kept the short term borrowing rates near Zero for more than four years, and has purchased U.S. treasuries and mortgage backed bonds to bring long term borrowing rates to record low. The Fed has taken such measures in order to fuel economic growth. Due to decline in the interest rates, there has been a greater demand for higher-yielding debt, increasing prices on dollar-dominated junk bonds to a record 105.9 cents on the dollar last month, as per Bank of America Merrill Lynch data.
According to the survey of Bloomberg, economists are expecting 10 year treasury yield to increase not more than a percentage point in the first half of 2014, but contrary to that, some investors are readily prepping for higher rates by investing huge amount of cash this month, into the leveraged loans linked to floating-rate benchmarks.
The Treasury Borrowing committee, which is a body of senior bankers headed by JPMorgan Chase & Co. (NYSE:JPM)’s Matthew Zames, in a presentation to Fed chairman, Ben S. Bernake, warned that the policies of central bank may be inflating bubbles in speculative grade of bonds and other asset classes. However, Bernake did not take the matter seriously.
Debt underwriting, both investment-grade and junk, contributed 40 percent to 63 percent of advisory and underwriting revenue, according to the reports. This was among the fastest growing revenue lines for the world’s nine biggest investment banks last year.
Warren Buffett, CEO of Berkshire Hathaway Inc, in his annual letter to investors warned against rise of fixed-income investments. The CEO said “bonds should come with a warning label” because such low-yielding investments probably would be eaten away by inflation. Earlier this month, Grantham Mayo Van Otterloo & Co.’s Jeremy Grantham wrote in his quarterly letter that some stocks are “brutally overpriced” and “as for fixed income — fugetaboutit.”