From triple A t-bills to Triple A ponzi
In Credit Ratings We Trust
=DJ Fewer Treasurys Means Triple-A Investors Face More Risk
01 May 16:37
By Christine Richard
Of DOW JONES NEWSWIRES
NEW YORK (Dow Jones)--Global investors have been piling into U.S.
dollar-denominated investment grade-rated debt but increasingly their holdings
are made up of non-Treasury securities.
That means despite a broadening array of triple-A credit to choose from,
global fixed income investors are taking on more credit, prepayment and
liquidity risk than ever before.
"There are a number of trends that are giving more investors a bias toward
higher quality at the very point when quality is in decline," said Robert
Smith, head of Smith Affiliated Capital in New York. "A decline in the issuance
of government debt means a decline quality paper."
According to a recently released Merrill Lynch survey, the government share
of the $31.4 trillion world bond market continued to decline for a five
straight year in 2000. That didn't slow the demand for high-rated U.S. dollar
debt, however, with Merrill reporting that corporate, mortgage and agency debt
more than filled the void left by disappearing Treasurys.
The Treasury market declined to $3.2 trillion at the end of 2000 from $3.6
trillion at the end of 1996, a $400 billion drop.
But growth in triple-A-rated agency debt took up the slack, with outstanding
paper increasing to $1.8 trillion at the end of 2000, up almost $1 trillion in
four years.
Add to the triple-A mix nearly $1 trillion in asset-backed debt, much of
which carries a high investment-grade rating, and investors were spoilt for
choice.
But unlike U.S. Treasury debt, which has an intrinsic triple-A rating, the
growing parts of the triple-A market frequently obtain their top rating through
enchancements such as credit insurance, over-collateralization or actual or
implied guarantees, according to John Puchalla, senior economist at Moody's
Investors Service.
"There has been a big change in the relative shareof the triple-A market and
the dominance of Treasurys," Puchalla said.
Riskier Triple A
Those changes have translated into more risk for investors.
"The fact that you are buying triple-A is no great protection," said Smith.
"In this day and age, credit events happen faster and there is more leverage
with far more off-balance sheet financing," said Smith. "In this environment
you're liable to get far more surprises."
"We saw Xerox go from double-A to less than investment grade in quarter,"
Smith said.
Karim Basta, senior global fixed income strategist at Merrill Lynch, who
discussed the results of the survey in a conference call on Monday, said
investors had to be more focused on credit risk.
"Credit risk, as determined by the direction of swap spreads, is becoming an
ever more important factor to determine performance," Basta said.
Falling government issuance has "led global fund managers to shift their
benchmark performance indices from pure government indices to those that
include all investment-grade debt," the report said.
The Risk Of Lower Rates
Another risk factor as Treasurys decline and other debt takes its place is
pre-payment risk.
According to the Merrill Lynch survey, mortgage debt exceeded that of
Treasury market debt for the first time in 2000. The agency market alone is
expected to surpass the Treasury market by the end of 2002, the report said.
"Agencies have tried to fill the void on providing core protection, but
there is a lot of variable-rate paper out there and a lot of callable paper,"
Smith said. "For pension funds, that has created major problems in this latest
round of refinancing."
Liquidity Is King
Finally, the reassurance that comes from being able to find numerous bidders
for a U.S. Treasury anytime, anywhere, doesn't extend to all triple-A debt.
Particularly for highly-structured debt, the liquidity situation "leaves a
lot to be desired," said Smith. "You have one market maker forthe bond, the
guy who created it."
Puchalla said that many of the largest issuers, including the agencies, have
attempted to address these liquidity concerns by creating their own benchmark
issues.
Fannie Mae (FNM), Freddie Mac (FRE) and corporate issuers such as Ford Motor
Credit Corp., the finance arm of Ford Motor Co. (F), have sold benchmark deals
of around $5 billion, compared with a typical Treasury auctions of $10 billion.
There are advantages to creating large, liquid benchmark, said Puchalla, but
"certainly, the Treasury market is still always going to be more liquid."
"It isn't the end of the world if you don't have 30-year Treasurys," said
Smith. "But the fact of the matter is that it makes life a lot more awkward,"
Smith added.
-By Christine Richard, Dow Jones Newswires; 201-938-2189;
christine.richard@dowjones.com
(END) DOW JONES NEWS 05-01-01
04:37 PM |
