Sales of Bonds With Floating Rates Sink

By Mike Cherney 

        Sales of corporate bonds whose interest payments rise and fall with market benchmarks are down nearly 40% this year, another sign investors are skeptical after several false starts that U.S. interest rates will rise significantly in coming years.
        Food conglomerate Kraft Heinz Co., power-plant operator Exelon Corp., regional bank Huntington Bancshares Inc. and energy firm ConocoPhillips have canceled sales of floating-rate notes in recent months. Roughly $71 billion of floating-rate corporate debt has been sold this year in the U.S., down from $116 billion at this point last year and the lowest level since 2012, according to data provider Dealogic.
        Interest payments on "floaters," as investors call them, are generally set below fixed-rate bonds but offer protection against rising rates by moving in tandem with the broader market.
        For investors, that is potentially appealing in a year when the Federal Reserve is expected to raise its fed funds overnight bank-lending rate for the first time since 2006. For companies, the bonds offer an opportunity to reduce immediate borrowing costs and attract a wider range of investors.
        But many investors say they are cautious on floating-rate debt, given that they expect any rate increases from the Fed to be gradual amid turmoil overseas and mixed economic data at home.
        Given that rate outlook, investors say the higher yields on fixed-rate bonds offer a better deal.
        There is a "benign rate outlook that seems to have crept into the market over the last couple of months," said Joe Lynagh, who oversees the $577 million T. Rowe Price Ultra Short-Term Bond Fund. "You have a lot of question marks."
        Mr. Lynagh's fund is 20% invested in floating-rate debt, but he said an allocation of 40% or 50% would be reasonable if the Fed were expected to move aggressively on rates.
        The decline in floating-rate note sales doesn't mean companies aren't able to sell all the bonds they need. Instead, firms are obliging investor demand for fixed rates. In the U.S., fixed-rate corporate debt sales are roughly $945 billion so far this year, an increase of 18% from last year and the highest level on record, according to Dealogic data.
        Wall Street economists have been predicting for years that the Fed is poised to increase its target for the federal-funds rate, the interest that banks pay to borrow money from each other overnight. But the Fed has kept the rate, which broadly affects borrowing costs for households and businesses, near zero since 2008 to keep the U.S. economic recovery on track.
        Analysts now say the Fed could increase the target rate as soon as September with the economy gaining steam, and Fed Chairwoman Janet Yellen said in congressional testimony Wednesday that it is likely the central bank will increase the rate later this year. But some bond buyers believe the rate increase, if any, will be small.
        Kent White, portfolio manager and director of investment-grade research at Thrivent Asset Management, which oversees $96 billion, said he has been avoiding floating-rate bonds. He said a recent bond deal from Baxalta Inc., a pharmaceutical company spun off from Baxter International Inc., illustrates his point. The company sold three-year debt with both fixed and floating rates. The floating-rate bond priced to yield 1.06%, and the fixed-rate bond priced to yield 2.02%.
        "That's a lot of yield to give up unless you have a pretty aggressive view on the Fed's tightening path," Mr. White said.
        Bankers say they are still recommending floating-rate debt to companies, given that not all investors have the same outlook on where rates are headed. But preference for fixed-rate debt among investors is swaying companies' decision to cancel floating-rate portions.
        Exelon said it "ultimately favored fixed-rate bonds in response to investor demand," and ConocoPhillips said it sees "much greater market depth for fixed-rate debt." Huntington said it sells bonds "based on whichever rate structure provides the best pricing outcome." Kraft Heinz declined to comment.
        Still, companies also have an incentive to go fixed rate. Many floaters have short-term maturities, meaning a company could have to refinance its bond in a few years when rates may be substantially higher.
        A fixed-rate bond locks in the current low rates until the bonds mature.
        TCH LLC, which oversees about $12 billion and is a subsidiary of BMO Global Asset Management, has been holding steady on its allocation to corporate floating-rate debt, said portfolio manager Scott Kimball. The $1.1 billion BMO TCH Core Plus Bond Fund has about 10% to 15% of its assets in those bonds, Mr. Kimball said.
        Given the Greek debt crisis and other events overseas, the "overall environment is supportive of stable interest rates," Mr. Kimball said.
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        Access Investor Kit for Huntington Bancshares, Inc.
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        (END) Dow Jones Newswires

        July 19, 2015 19:13 ET (23:13 GMT)

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