Whither BBB Bonds? Milken Panel Sees Risks, Rewards in Wild Ride

(Bloomberg) -- Investors in the lowest rung of investment-grade U.S. corporate bonds are in for a continued wild ride as companies battle to reduce leverage and heightened volatility may present buying opportunities.

Bonds rated BBB comprise almost half of the investment-grade market, raising the question of what happens if a recession drives many of those securities into high-yield territory, Michael Buchanan, deputy chief investment officer at Western Asset Management, said Tuesday at the Milken Institute Global Conference in Beverly Hills, California. Investors got a glimpse of this in December when a sell-off unnerved many in the market.

“There is a huge risk here but corporate management teams are very aware of this,” he said. “We're in an early stage of that reversal of that leveraging trend.”

After a decade-long buying spree, many companies have pushed leverage to levels typical of junk-rated borrowers in their sectors, a Bloomberg News analysis found in October. That could lead to a situation during a recession when companies that have promised to lower their leverage are unable to do so, said Anne Walsh, CIO for Guggenheim Partners. “You could see a tremendous default wave or downgrade cycle,” she said at the conference.

A shift of many BBB rated companies into junk would be bad timing because there's no demand for long-dated high-yield bonds, said Jude Driscoll, head of public fixed income at MetLife Investment Management. On the bright side, “these companies generate a lot of cash flow so the ability to delever is there,” he said.

The Federal Reserve helped calm nerves in December when it backed off a plan for more aggressive rate hikes in 2019.

“What we expect to happen is to continue to see V-shaped trading,” said Justin Slatky, co-CIO at Shenkman Capital Management. “From an investment perspective, you really need to have to be prepared to quickly take advantage of those sell-offs.”

Guggenheim's Walsh said the corporate bond market recalls the excess borrowing that led to the housing crisis in 2008.

“The over-leverage is in corporate America,” she said. “This is where we feel the risk is, and right now you're not getting paid to take that risk.”

--With assistance from Kelsey Butler.

To contact the reporter on this story: Matthew Leising in Los Angeles at mleising@bloomberg.net

To contact the editors responsible for this story: Michael J. Moore at mmoore55@bloomberg.net, Dan Reichl, Josh Friedman

©2019 Bloomberg L.P.