MetLife is expanding its portfolio of investment and speculative-grade debt. Photographer: Daniel Acker/Bloomberg U.S. life insurers are boosting their holdings of corporate bonds at the fastest rate in six years in an effort to jolt returns by taking on more credit risk amid near-zero interest rates.
Net purchases by the insurers climbed to a seasonally adjusted annual rate of $165.4 billion last quarter from $64.5 billion in the three months ended June 30, the biggest inflow since 2004, according to data released by the Federal Reserve in Washington last week. For the first time, they now own more than $2 trillion in the securities issued by companies.
Even after a rally that generated returns of 43 percent since debt markets began to recover in March 2009 from the worst financial crisis since the Great Depression, U.S. corporate bonds still yield 2.58 percentage points more than Treasuries, according to Bank of America Merrill Lynch index data. Spreads averaged 1.94 points in the five years before credit markets began to seize up in mid-2007.
“In 2008, 2009 it was all about preserving capital and liquidity, but now they’re looking to enhance the yield on their portfolios,” Andrew Edelsberg, a vice president in A.M. Best Co.’s life and health insurer ratings division, said in an interview last week. “They’ve been deploying the new funds into corporates because earnings have been better for companies given the stabilization of the economic environment.”
MetLife, Aflac
New York-based MetLife Inc. is expanding its portfolio of investment- and speculative-grade debt, and Aflac Inc. is buying as much as $1 billion of corporate bonds through year-end, according to officials at the companies.
Life insurers “don’t tend to be quick sellers, so if we ever had a liquidity problem, they wouldn’t be ones to immediately dump in a market,” said Anthony Valeri, a market strategist in San Diego with LPL Financial Corp., which oversees $293 billion. “In any market, a greater number of players is better.”
Elsewhere in credit markets, the extra yield investors demand to own corporate bonds worldwide rather than government debentures narrowed last week by the most since July. The cost of protecting company debt from default in the U.S. declined to the lowest level in five weeks. Leveraged loan prices rose. In emerging markets, spreads tightened for a second week.
Yields on company debt from the U.S. to Europe and Asia narrowed 5 basis points relative to government bonds last week to 171 basis points, or 1.71 percentage points, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. Spreads had the biggest weekly drop since declining 6 basis points in the period ended July 23. Yields jumped to an average 3.96 percent from 3.83 percent.
Issuance Surges
Corporate bond sales worldwide surged to $60.1 billion for the week, from $47.9 billion in the prior period, according to data compiled by Bloomberg. Whitehouse Station, New Jersey-based Merck & Co. sold $2 billion of debt on Dec. 7 in a two-part offering. The drugmaker’s $1.15 billion of 3.875 percent notes fell 0.9 cent from the issue price to 98.786 cents on the dollar as of Dec. 10, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Credit-default swaps on the Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, fell for a second week, declining 4.37 basis points to 87.25 basis points, the lowest since Nov. 5, according to Markit Group Ltd.
In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings rose 0.96 to 107.92, the highest since Dec. 1.
The default-swap indexes typically fall as investor confidence improves and rise as it deteriorates. 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.
Leveraged Loans
The Standard & Poor’s/LSTA US Leveraged Loan 100 Index rose 0.28 cent for the week to 92.04 cents on the dollar, the highest since Nov. 18. The index, which tracks the 100 largest dollar- denominated first-lien leveraged loans, has gained 8.4 percent this year.
In emerging markets, relative yields narrowed 12 basis points to 228 basis points, after declining the same amount in the prior week, according to JPMorgan Chase & Co. index data.
Globally, sovereign debt has lost 2.63 percent this quarter, compared with a loss of 2.19 percent on corporate bonds, according to Bank of America Merrill Lynch index data. For the year, government debt has gained 3.34 percent versus 6.66 percent for company debentures.
‘Little More Attention’
Life insurers’ company debt holdings, measured by book value, compare with $1.96 trillion in the second quarter and $1.89 trillion in the three months ended September 2009, according to the Fed’s Flow of Funds Accounts of the United States report released Dec. 9. The figure also includes foreign corporate bonds. Net purchases last quarter were the most since $182.8 billion of inflows in the three months ended March 2004.
“They’re buying a lot of U.S. corporates, investment-grade corporates,” Douglas Meyer, an insurance analyst with Fitch Ratings, said in an interview. “Corporates have always been a mainstay, and I think it’s just getting a little more attention right now” because of the decline in structured-securities issuance following the financial crisis, he said.
Sales of asset-backed securities, including debt tied to auto loans and credit cards, may fall to $93 billion this year, from $138 billion in 2009, according to a Dec. 9 report from Citigroup Inc. analysts led by Mary Kane in New York. Issuance may rise 14 percent to $106 billion in 2011, according to the report.
Recover Lost Capital
The corporate-debt rally is helping insurers including MetLife and Newark, New Jersey-based Prudential Financial Inc. recover capital lost in the housing and stock market slumps of 2008 and early 2009. Life insurers, which can hold policyholder premiums for decades before paying claims, need to earn returns on those funds to pay workers, remunerate investors and ultimately satisfy customers.
MetLife, the largest U.S. life insurer, said that investment-grade bonds, which account for 35.5 percent of its portfolio, will probably rise to about 36.75 percent of total holdings next year. Junk bonds, rated below Baa3 by Moody’s Investors Service and lower than BBB- by Standard & Poor’s, may make up 5 percent of the portfolio from 4.5 percent.
Investment-grade bonds have gained 8.65 percent this year, compared with the 14.16 percent on junk bonds, Bank of America Merrill Lynch index data show. That compares with the 5.59 percent increase for Treasuries.
Private Lending
MetLife also expanded private lending to corporations to $46 billion from about $35 billion at the end of last year’s third quarter, as Chief Investment Officer Steven Kandarian seeks to bolster returns on the firm’s $443 billion portfolio.
Historically, the privately placed debt pays as much as 50 basis points more than similarly rated public corporate bonds, and last year paid a premium of more than 70 basis points, Kandarian said in December 2009.
“In four of the last five years, we’ve been the No. 1 asset originator in this sector,” Kandarian said Dec. 6 at a presentation in New York, where MetLife is based. “You get paid an illiquidity premium for holding these kinds of securities.”
Columbus, Georgia-based Aflac, the world’s biggest seller of supplemental health insurance, is shifting from Japanese government securities and focusing on dollar-denominated corporate debt rated A with a duration of about 10 years. Japanese government bonds due in 7 to 10 years yield about 0.99 percent, compared with 4.52 percent for A rated U.S. corporate debt.
Support Stability
“Given that interest rates are so low you have to look at your duration preferences,” Kriss Cloninger, president and chief financial officer of Aflac, said in an interview last week. “At the time we were placing the money, we felt the risk- reward advantage was with shorter-duration corporates as opposed to the longer-term Treasuries.”
Life insurers helped support stability in long-duration bonds last week as Fed Chairman Ben S. Bernanke said the central bank may expand bond purchases, LPL’s Valeri said. Yields on 5- and 10-year Treasuries jumped at least 30 basis points while yields on 30-year Treasury bonds rose 17 basis points.
“When you compare against the yields increase in 5-year bonds, 10-year bonds, the magnitude isn’t as correspondingly large,” LPL’s Valeri said. “Pension funds and life insurance companies have long-term liabilities, and they view this sell- off here as an opportunity to get bonds at cheaper prices ultimately.”
As Treasuries yields rise, the appeal of corporate debt, already an “attractive” asset class, will increase for life insurers, said Rob Crimmins, a portfolio manager at policyholder-owned Guardian Life Insurance Co. of America.
“The higher we go, the better it’s going to be,” said Crimmins, who helps oversee about $8 billion in investment-grade corporate debt in New York. “It’s adding a lot of yield bogeys for pension funds or insurance companies that are saying, ‘finally, I can buy corporates at a 4.5 percent, 5 percent yield.’”
To contact the reporters on this story: Sapna Maheshwari in New York at sapnam@bloomberg.net; Andrew Frye in New York at afrye@bloomberg.net
To contact the editors responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net; Dan Kraut at dkraut2@bloomberg.net
