TOKYO -- Yield-hungry investors are snapping up long-term bonds as fast as companies can issue them, decoupling yield and creditworthiness in a way that could prove dangerous if interest rates begin to rise.
The boom in ultralong bonds with maturities over 10 years shows no signs of abating, said an official who underwrites corporate bond floats for a Japanese brokerage. The comment was made on Friday afternoon -- the same day the Bank of Japan decided against taking interest rates even further into negative territory. That negative-rate policy, introduced in February, kicked off the surge in long bonds. Noting the difficulty for investors to generate returns with more conventional instruments, the official said that issuance of long-term corporate debt would likely keep growing in August and beyond.
Ultralong bonds accounted for roughly 20% of Japan's corporate debt issuance in the first half of 2016, compared with 5-10% a year earlier. Companies looking to lock in low interest rates for the long haul have found willing partners in yield-starved investors. Enterprises in a variety of industries are entering the field, helping "grow opportunities for investment," said Haruyasu Kato of Mizuho Trust & Banking.
But the rush by institutional investors such as regional banks to snap up the debt has started to distort yields. Coupons on corporate bonds are typically set by placing a premium linked to a company's credit rating on top of government bond yields -- the less creditworthy a company is, the higher the payoff. Yet a look at the conditions for several recent and upcoming 20-year floats shows this correlation is crumbling.
Nippon Express, for example, on July 8 set a 0.7% coupon for a batch of 20-year bonds -- the same as on similar instruments from trading house Toyota Tsusho, despite the latter's lower credit rating. The shipper had considered a coupon in the 0.6% range, but is thought to have sweetened the deal as drugmaker Daiichi Sankyo prepared to court investors with payments on the 0.8% level. This is high for the pharmaceutical company's credit rating, which is even better than that of Nippon Express.
Thus in the current market, "yields are determined almost entirely by supply and demand," a corporate bond official at a securities company said. This calls into question whether investors truly understand the risks involved in long-term corporate debt.
The longer a bond has until repayment, the greater the danger is that interest rates in the broader economy will shift. A rate uptick of 1 percentage point could sink the price of a 20-year corporate bond with a 0.8% coupon by around 20%. If yields on government bonds climb or souring earnings damage a company's credit rating, impairment to a bond's value could outweigh interest income.
Any investor looking to pull a yield approaching 1% from Japanese bonds cannot afford to rule out long-term corporate debt. But those charging into the market blind to the risks they face only create problems for themselves farther down the road.