Pimco to DoubleLine Leveraging as Yields Retreat: Credit Markets
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Jan. 29 (Bloomberg) -- Junk-bond yields have fallen so far that the world’s biggest debt investors are turning to borrowed money to juice returns, a practice that magnified losses during the worst financial crisis since the Great Depression.
Bill Gross’s Pacific Investment Management Co. said it plans to sell as much as $3.3 billion of shares for its Pimco Dynamic Credit Income Fund, poised to become the largest taxable income closed-end fund. DoubleLine Capital LP is starting its Income Solutions Fund that may invest an unlimited amount of its assets in speculative-grade debt, according to a Jan. 15 filing.
Leverage is staging a comeback for investors that oversee more than $2 trillion as speculative-grade yields reach record lows daily with the Federal Reserve holding benchmark interest rates at about zero percent for a fifth year. Blackstone Group LP’s debt investment arm obtained a $425 million line of credit last month for its Strategic Credit Fund, which started trading in September as part of the biggest wave of initial public offerings for closed-end funds since 2007.
“Everybody’s looking for income,” said Sangeeta Marfatia, a strategist at UBS Securities LLC in New York. Closed-end funds “can go out and borrow really cheap and yet they’re able to invest at much higher rates.”
Pimco’s new fund may borrow as much as 42 percent of net assets, according to a Jan. 25 filing from the Newport Beach, California-based manager of the world’s largest bond fund. Initial public offerings of closed-end funds, which trade on exchanges and seek to boost gains using leverage, reached $11.6 billion last year, almost double the $5.9 billion in 2011, according to Thomas J. Herzfeld Advisors Inc. More than half of the new funds focused on credit investments.
Investors clamoring greater returns deposited an unprecedented $72.4 billion last year into funds that own speculative-grade debt, rated below Baa3 by Moody’s Investors Service and lower than BBB- at Standard & Poor’s, according to data from EPFR Global in Cambridge, Massachusetts.
While junk yields in the U.S. have plunged to 6.41 percent, bond buyers are still pouring cash into the notes as they speculate that the U.S. economy has “more upside than downside risk” in a low-rate environment, JPMorgan Chase & Co. credit strategists led by Peter Acciavatti in New York wrote in a Jan. 25 note.
Borrowed money invested in mortgage bonds accelerated losses during the credit crisis by forcing sales by holders as margin calls arose, boosting supply and sending prices lower.
“I don’t think you get a repeat of 2008 because the leverage in the system isn’t anything close,” Jeffrey Gundlach, chief executive officer of Los Angeles-based DoubleLine, with about $53 billion in assets, said last month in a Bloomberg Television interview. “You would need the leverage in the system to go up more, and maybe it will.”
Elsewhere in credit markets, Toronto-Dominion Bank, Bank of Nova Scotia and four other Canadian lenders had their credit ratings cut by Moody’s, which cited “high levels” of consumer debt and “elevated” house prices. General Mills Inc. raised $1 billion in its first benchmark bond sale in 14 months. OAO Rosneft is said to be seeking $13 billion of loans to help finance the second part of its acquisition of TNK-BP.
The U.S. two-year interest-rate swap spread, a measure of debt-market stress, rose 0.67 basis point to 16.62 basis points. That’s the highest level since Sept. 5 for the gauge, which widens when investors seek the perceived safety of government securities and narrows when they favor assets such as corporate bonds.
The cost of protecting corporate bonds from default in the U.S. rose. The Markit CDX North American Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, increased one basis point to a mid-price of 85.8 basis points, according to prices compiled by Bloomberg. The measure has climbed from 84.9 on Jan. 7, the least since Sept. 14.
The Markit iTraxx Europe Index of 125 companies with investment-grade ratings climbed 2.5 basis points to 108.5 at 10:20 a.m. in London, the highest since Dec. 31. The Markit iTraxx Asia index of 40 investment-grade borrowers outside Japan was little changed at 106.
The indexes typically rise as investor confidence deteriorates and fall as it improves. 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 contract protecting $10 million of debt.
Bonds of Fairfield, Connecticut-based General Electric Co. were the most active dollar-denominated corporate securities yesterday, accounting for 3.64 percent of the volume of dealer trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Toronto-Dominion, the last publicly traded bank to have the top grade from Moody’s, was cut to Aa1, the ratings firm said yesterday in a statement. Bank of Nova Scotia fell to Aa2 and the ratings on Bank of Montreal, Canadian Imperial Bank of Commerce, Caisse Centrale Desjardins du Quebec and National Bank of Canada were lowered by one level. Moody’s also removed systemic support from all rated Canadian banks’ subordinated debt, including those issued by Royal Bank of Canada.
“High levels of consumer indebtedness and elevated housing prices leave Canadian banks more vulnerable than in the past to downside risks the Canadian economy faces,” Moody’s said in a statement.
General Mills sold $250 million each of three-year, fixed- and floating-rate debt, with 0.875 percent notes yielding 45 basis points more than similar-maturity Treasuries and bonds at 30 basis points more than the London interbank offered rate, according to data compiled by Bloomberg. The Minneapolis-based maker of Cheerios cereal also issued $500 million of 30-year, 4.15 percent securities at a spread of 105 basis points.
General Mills last sold benchmark debt in November 2011, issuing $1 billion of 3.15 percent, 10-year debentures to yield 125 basis points more than similar-maturity Treasuries, Bloomberg data show.
OAO Rosneft, Russia’s largest oil company, asked lenders for a $3.2 billion five-year loan and a $9.8 billion two-year facility, according to three people with knowledge of the deal. Rosneft is offering lower interest margins on the debt compared with the $16.8 billion of loans the Moscow-based company raised in December to pay for BP Plc’s stake.
In emerging markets, relative yields were little changed at 256 basis points, or 2.56 percentage points, according to JPMorgan Chase & Co.’s EMBI Global index. The index has fallen from 265.8 at year-end.
Pimco’s Dynamic Credit Income Fund intends to borrow money “as soon as reasonably practicable following the completion of the initial public offering,” according to the Jan. 25 prospectus. It may invest in a range of fixed-income securities, from corporate debt and mortgage-backed securities to government and municipal bonds.
If the new fund succeeds at raising the full $3.3 billion, it will become the biggest taxable-income closed-end fund, according to data from Morningstar Inc. It will be the largest closed-end fund IPO since the Eaton Vance Tax-Managed Global Diversified Equity Income Fund, which raised $6.03 billion in February 2007, according to Ipreo, a New York-based provider of market data.
Pimco’s $1.36 billion Dynamic Income Fund, its closed-end fund that started last year, has returned 29 percent including reinvested dividends since its inception on May 24, compared with 12.5 percent for the Bank of America Merrill Lynch U.S. High Yield index.
DoubleLine’s Income Solutions Fund “may invest in debt securities and other income-producing investments of any kind,” including an unlimited amount of securities rated below investment grade, according to a Jan. 15 filing. It also intends to borrow money through reverse-repurchases agreements, dollar- roll transactions, loans or lines of credit.
Mark Porterfield, a Pimco spokesman, and Loren Fleckenstein, of DoubleLine declined to comment on the new closed-end funds.
“Many investors are searching for income, they’re looking at closed-end funds as a good way to receive a more attractive yield,” said Cecilia Gondor, executive vice president at Miami- based Thomas J. Herzfeld Advisors Inc. “Closed-end funds tend to use more leverage than open-end funds because they don’t have to worry about cash inflows and outflows.”
Unlike with mutual funds, money for closed-end funds is raised through an IPO. The number of shares outstanding is then fixed, with investors buying and selling units of the fund on the stock exchange.
Blackstone’s GSO Strategic Credit Fund obtained a credit line with up to $425 million available, according to a Dec. 21 release, making its potential total size $1.28 billion based on current net asset value.
KKR & Co. filed last year to create the Alternative Corporate Opportunities Fund, which has a closed-end structure and will invest in “special situations, direct lending and mezzanine finance,” co-chairman Henry Kravis said in a Dec. 4 presentation.
The Fed has held its benchmark interest rate between zero and 0.25 percent since December 2008, seeking to ignite an economy wounded by $2.1 trillion in global writedowns and credit losses from the financial crisis that began in 2007.
While the U.S. unemployment rate has declined to 7.8 percent from 10 percent at its 2009 peak, the average estimate of 83 economists surveyed by Bloomberg is for growth this year of 2 percent following 2.3 percent in 2012.
Prices on speculative-grade bonds have soared to an unprecedented 105.9 cents on the dollar, according to Bank of America Merrill Lynch index data. Yields on the index fell to 6.41 percent as of Jan. 25 from last year’s high of 8.46 percent last Jan. 3.
Closed-end funds have been able to take advantage of the record-low borrowing costs to increase returns, even as yields plunge, attracting individuals who rely on interest to pay monthly bills, said UBS’s Marfatia.
“A lot of the closed-end funds pay monthly dividends,” Marfatia said. “It’s all about income.”
--With assistance by Sean B. Pasternak in Toronto, Stephen Morris in London and Sarika Gangar in New York. Editors: Alan Goldstein, Faris Khan