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The bond craze


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#1 dcengr

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Posted 11 January 2007 - 12:02 AM

Buffett, Verizon Buoyed by China, U.K. Debt Appetite (Update1)

By Caroline Salas

Jan. 9 (Bloomberg) -- Even when Warren Buffett gets it wrong, there's a silver lining.

The world's second-richest man, who has recommended avoiding the dollar the past four years because the trade deficit makes American assets less attractive, is benefiting from the greatest international demand for U.S. corporate bonds ever.

Buffett's Omaha, Nebraska-based Berkshire Hathaway Inc. and hundreds of companies need to refinance a record $552 billion of debt this year, according to data compiled by Morgan Stanley. They may benefit from relative borrowing costs near the lowest since 1999 as investors in Europe and Asia substitute corporate bonds for Treasuries, Credit Suisse Group data show.

Foreigners bought a net $386 billion of company debt through October last year, a 29 percent increase from the same period in 2005, as purchases of U.S. government bonds fell by about half to $143 billion, according to data released last month by the Treasury Department.

``The environment for corporate issuance in 2007 has never been as positive,'' said Thomas Lewis, head of investment-grade bond underwriting at New York-based Morgan Stanley. ``If it was on a one to 10 scale, you'd be pretty close to a 10. The pool of cash has grown dramatically in the last 12 to 18 months.''

Companies may save as much as $1.6 billion a year in interest because of the buying spree, based on estimates by Credit Suisse.

Investment-grade bonds yield an average of about 99 basis points more than Treasuries, or 10 basis points to 20 basis points less than they would without the international demand, said Ira Jersey, a strategist at Credit Suisse in New York. A basis point is 0.01 percentage point.

No End in Sight

``Foreign buying has been the single largest contributing factor to demand for corporates,'' Jersey said. ``We don't see any reason for that not to continue.''

In 2005, net purchases of company debt by foreigners totaled $372 billion, compared with $339 billion for government bonds, according to the U.S. Treasury. The year before, international buyers favored Treasuries over corporate bonds, $352 billion to $310 billion. November's figures will be released on Jan. 17.

China intends to diversify its foreign-exchange reserves while hanging onto its dollar holdings, People's Bank of China Governor Zhou Xiaochuan said at a Frankfurt conference sponsored by the European Central Bank in November.

Chinese banks ``need to diversify their investments to products with higher yields,'' said Zong Liang, a senior analyst at Bank of China's International Financing Institute in Beijing. ``They don't want to put all their foreign exchange holdings in one basket with U.S. Treasuries. Chinese banks and other financial institutions will buy more foreign corporate bonds in the future.''

Higher Yields

Investment-grade bonds in the U.S. yield about 5.64 percent, half-a-percentage point less than the average since 1996, according to data compiled by Merrill Lynch & Co. Bonds rated above Ba1 by Moody's Investors Service and BB+ by Standard & Poor's are considered investment grade.

``There certainly seems to be a lot of cash looking for a home,'' said Andrew Aran, director of global credit strategies at AllianceBernstein LP in New York who helps manage more than $180 billion. Demand is ``more international than ever. It was hard a year ago and getting harder'' to find bonds that offer high relative yields, he said.

Companies are taking advantage of the demand to sell more debt. Investment-grade offerings totaled a record $880 billion in 2006, and may top $800 billion again this year, said Jeffrey Rosenberg, head of credit strategy at Bank of America Corp.'s securities unit. Sales in 2004 and 2005 totaled $639 billion and $669 billion, according to data compiled by Bloomberg.

Berkshire Bonds

Berkshire Hathaway has about $2.08 billion of bonds maturing in 2007, Bloomberg data show. The company's $700 million of 4.75 percent debt due in 2012 traded yesterday at about 99 cents on the dollar to yield 39 basis points more than Treasuries of similar maturity, according to Trace, the bond-price reporting system of the NASD. The yield premium was 80 basis points when they were sold in May 2005.

Chief Financial Officer and Treasurer Marc Hamburg declined to comment.

Buffett addressed his currency losses in a letter to shareholders in March. ``My views on America's long-term problem in respect to trade imbalances, which I have laid out in previous reports, remain unchanged,'' Buffett wrote. ``My conviction, however, cost Berkshire $955 million pretax in 2005.''

Lower Cost

International demand for U.S. bonds may help cut Buffett's interest costs. Berkshire Hathaway's MidAmerican Energy Holdings Co. utility subsidiary has $350 million of 10-year, 7.63 percent notes due in October. The company would likely pay about 5.94 percent on bonds to refinance the securities, based on a Merrill Lynch index of debt with BBB credit ratings that mature in 11 years on average. That would save MidAmerican almost $6 million a year in interest.

``We've gradually increased our purchases of U.S. corporate bonds,'' said Park Insung, head of the overseas investment group at Seoul-based Samsung Life Co. South Korea's biggest life insurer manages foreign-currency bonds equivalent to $10.7 billion. ``We mostly invest in single A, 10-year corporate bonds as they are liquid, stable and profitable.''

Investors from Persian Gulf countries probably increased U.S. corporate debt holdings by 3 percent to 5 percent in the past year, with bondholders from Saudi Arabia and Kuwait adding as much as 7 percent, said Bruno Martorano, an adviser to wealthy clients for Ansbacher Middle East in Dubai, a unit of Qatar National Bank.

`Increasing Interest'

``There is an increasing interest from Middle East clients in U.S. corporate bonds as a means to spice up returns,'' Martorano said.

Most of the demand comes from the U.K., the financial hub for international investors, especially those in the Middle East. U.K.-based investors bought a net $195 billion through October, according to U.S. Treasury data.

The world's main oil-exporting countries are putting about half their windfall from higher energy prices in U.S. financial markets, according to a Federal Reserve Bank of New York report last week. The regional Fed bank, which holds Treasuries on behalf of foreign central banks and international accounts, estimated that the exporters had about $970 billion in oil revenue last year, more than triple the 2002 figure.

Time Warner

Time Warner Inc., the world's largest media company, has more than $1.5 billion of notes maturing this year, including $546 million of 8.18 percent notes due Aug. 15. The New York- based company may pay about 2 percentage points less in interest to refinance the debt with new bonds, based on recent prices for its securities, which are rated Baa2 by Moody's and BBB+ by S&P.

Verizon Communications Inc., the second-largest U.S. telephone company, has almost $4 billion of bonds due. The New York-based company's $1 billion of 6.125 percent debt maturing in June is rated A3 by Moody's and A by S&P. The notes were sold in 2002.

Verizon would likely pay a coupon of less than 6 percent to replace the notes with seven-year securities because investment- grade phone and utility bonds maturing in seven years yield 5.7 percent on average, Merrill Lynch index data show.

About 79 percent of the debt that matures this year was issued by financial companies, according to Banc of America Securities LLC. The rest is industrial debt. Of that, utilities issued 20 percent, consumer non-cyclicals accounted for 17 percent, telecommunications companies sold 13 percent and media corporations borrowed 5 percent.

Rising Debt

Merrill Lynch's index of U.S. investment-grade corporate bonds contains about $2 trillion of debt with an average yield of 5.64 percent. Its European index holds $891 billion of bonds with an average yield of 4.45 percent. As recently as three years ago, the gap in yields was only about 0.3 percentage point.

``The spread pickup in Europe and Japan is not as good as the spread pickup in the U.S.,'' said Mathew McCrum, who oversees the equivalent of $10.8 billion of debt at Vanguard Investments Australia in Melbourne. The firm is part of Vanguard Group in Valley Forge, Pennsylvania, the second-biggest U.S. mutual-fund company.

Foreigners owned 29.3 percent of the $8.9 trillion of U.S. corporate debt outstanding in September, Fed data released last month show. That's up from 27.7 percent in 2005 and 26.9 percent the year before. By comparison, they own about half the more than $4 trillion of Treasuries outstanding.

`Careful Balance'

Low rates are prompting U.S. corporations to borrow. Total net debt for non-financial companies grew by 7.3 percent through the third quarter of 2006, and may increase by 8 percent this year, said John Lonski, chief economist at New York-based Moody's.

``That faster rate of growth for outstanding debt would be consistent with a credit cycle'' that has peaked, Lonski said. ``For the first time in several years, the growth of corporate debt will surpass the growth of corporate revenues.''

Banc of America recommends investors ``underweight'' investment-grade and high-yield corporate bonds because they are ``priced to perfection'' and offer ``very little room for error,'' according to Rosenberg, the firm's chief credit strategist.

Investment-grade bonds returned 4.4 percent last year, including reinvested interest, Merrill Lynch index data show.

``There's a careful balance that the market hasn't yet been tested on: Between its desire for yield and supply, and supply that that is undermining credit quality,'' Rosenberg said.

Bullish Bondholders

Borrowers flush with profits in an expanding economy are showing little concern about adding debt. The global default rate for speculative-grade debt was 1.82 percent in November, below the average of about 5 percent since 1979, Moody's says.

``Supply that undermines credit quality will ultimately be a catalyst for wider credit spreads, but that has yet to happen,'' Rosenberg said. ``It's barely keeping up with reinvestment needs.''

Companies in the S&P 500 posted income growth of at least 10 percent for a 13th consecutive quarter in the July-to-September period, matching the longest stretch of increases since 1950. The economy will accelerate to a 2.9 percent annual rate by year-end from 2 percent last quarter, according to the median estimate of 79 economists surveyed by Bloomberg from Dec. 1 to Dec. 8.

Corporate-bond investors are the most bullish since September 2005, according to JPMorgan Chase & Co.'s monthly survey of institutional clients. In December, 77 percent of managers were either ``overweight'' or ``marketweight'' corporate bonds, up from 61 percent in November, the survey showed. Investors ``underweight'' debt by owning a smaller percentage than is contained in benchmark indexes.

``The marked reduction in bearish sentiment speaks to a significant resumption in risk appetite that has accompanied'' earnings gains, as well as ``economic data suggesting that the economy is headed for a soft landing,'' Edward Marrinan, head of North American credit strategy at JPMorgan, the second-biggest underwriter of corporate bonds, said in his 2007 outlook report.
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#2 briarberry

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Posted 11 January 2007 - 07:08 AM

UK rate up 0.25% to 5.25%