Don’t be deceived by the recent rise in Treasury prices (and drop in yields). The U.S. fixed-income market is reaching the end of its three-decade bull run. Issuance of ultra-long corporate bonds — that is, paper maturing in longer than 30 years — continues to run near all-time highs, as companies act to take advantage of near-record-low interest rates before they rise. This may turn out to be a deal for companies and a steal from investors — who stand to bear the brunt of the risk.
When interest rates finally go up, those holding long-term bonds will likely get hammered. Pension funds and insurance companies may be matching the maturities of their assets and liabilities through their purchase of ultra-long bonds. But if the assets fall in value — and the income provided by them is well below market rates — that doesn’t amount to a very good investment.
“From the issuer’s standpoint, this is the opportunity of a century,” says Martin Fridson, veteran Wall Street credit analyst and chief investment officer at New York–based money management firm Lehmann, Livian, Fridson Advisors. Whereas rates haven’t risen off their lows yet, ultimately that is almost certain to happen. “A corporate treasurer who issues bonds at today’s rates will go down in the annals of his company as a brilliant guy,” says Fridson.
Through mid-September, U.S. companies have issued $49.78 billion of ultra-long bonds across 99 deals, close to last year’s record total of $50.76 billion for the same period. Issuers of ultra-long bonds this year include Caterpillar Inc., Entergy Corp., Guardian Life Insurance Co. of America and SCANA Corp., all of which placed 50-year paper. Peoria, Illinois–headquartered Caterpillar, which launched its ultra-long bond in May, saw its issue total $500 million.
The median yield on ten-year single-A corporate bonds stands at 3.12 percent, compared with 4.11 percent for such bonds with maturities of more than 30 years, according to Bank of America Merrill Lynch Global Research. The ten-year bonds have a yield premium of 103 basis points over ten-year Treasuries, whereas the 30-plus-year bonds have a 129-basis-point yield premium over 30-plus-year Treasuries.
Companies are using the bond proceeds for general corporate purposes, including M&A activity and share buybacks. In addition, “they’re also diversifying their funding, filling out the maturity spectrum,” says Ashish Shah, head of global credit for AllianceBernstein.
This trend might turn out poorly for investors, Fridson says. “On a mark-to-market basis, buyers may not look good in the future when interest rates rise,” he explains. “Some investors are more sensitive than others. There’s more hedging ability than there used to be. But it’s not easy to hedge a 40-year bond.”
The raft of ultra-long bonds might in itself be a dangerous sign. “Typically, when you see heavy issuance of ultra-long bonds, it comes at turning points,” Shah says. “Yields are low, or spreads are tight. Afterward, people scratch their heads and say they wish they wouldn’t have bought.”
But Andrew Karp, co-head of Americas investment-grade capital markets for Bank of America Merrill Lynch, sees a positive implication too. “In some cases the company’s decision to lock in long-dated financing is driven by its view that the overall level of economic activity is increasing,” he says. “As we see more companies behave this way, it sends a bullish signal about the economy broadly.”
So what is the outlook for future ultra-long bond issuance? “I think corporations will continue to take advantage of this for as long as they can,” Fridson says. When expectations build that long-term rates will rise, then demand will dry up, he says.
But Shah sees the trend dying down within several weeks. “We have had a number of issuers,” he says. “It will get to the point that we have saturated demand. Only limited issuers have the strength to do it.”
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