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Wells Fargo Analysts See Big Refinance Risk in `Bad Boy Bonds'

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“Bad boys, bad boys whatcha gonna do? Whatcha gonna do when [the rating agencies] come for you?”

So begins Wells Fargo’s note Wednesday on the potential refinance risk lurking in the part of the global investment-grade market that’s grown most since the financial crisis: BBBs. Or, in their team’s alliterative phrasing, the bad boy bonds.

U.S. corporate bonds that fall into this category, which is just above junk status, have lost 2.5% this year for investors, nearly the worst among slices of the investment-grade market.

(Related: Corporate Bonds Are Getting Junkier)

Faced with an economic expansion that’s getting long in the tooth and short-term interest rates grinding steadily higher, things could go from bad to worse for this behemoth of the bond market.

To this end, credit strategists Nathaniel Rosenbaum and Winifred Cisar compiled a list of 21 global firms that have at least 50% of their debt maturing in the next five years, thinking that these issuers might be forced to raise capital in a particularly unfavorable environment.

“Using the consensus assumption that the U.S. is due for a recession in the next few years, companies with front-loaded maturity schedules are more likely to have debt ‘in the wrong place at the wrong time,’” wrote Rosenbaum and Cisar. “We encourage investors to pare positions in BBBs with exposure to macroeconomic headwinds, such as the Autos, which have become the beta sector for trade war-related headlines.”

In the event any of the aforementioned issuers get cut to junk, their limited amount of outstanding longer-term bonds would be prone to “outsized mark-to-market” losses, according to the pair, due to a dearth of natural buyers of duration among high-yield investors.

The fate of these issuers is a matter of no small import. BBBs make up half of the more than $5 trillion investment-grade market, and business investment has grown by about 2 percentage points as a share of the U.S. economy since the end of the Great Recession, according to Wells Fargo.

“BBB debt, which is arguably a systemic economic benefit for the moment, is set to become a systemic economic risk when this source of growth eventually peters out,” the analysts said.

Editor’s Note: Why This Could Matter to Agents

Any problems that rattle the investment-grade bond market could rattle life insurers, because life insurers use large amounts of investment-grade bonds in the general account portfolios supporting their life and annuity operations.

Life insurers ended 2016 with about $841 billion in BBB-rated bonds, according to an analysis distributed by the National Association of Insurance Commissioners.

Life insurers have about $2.1 trillion in corporate bonds, and about $4.3 trillion in general account assets of all kinds, according to the American Council of Life Insurers.

— Read Thirsty Life Insurers See Bond Yields Rise to Highest Level in Five Yearson ThinkAdvisor.


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