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Home woes don't hurt most bonds

Investors shun securities linked to high-risk mortgages but hang on to other dicey bets.

March 13, 2007|Tom Petruno | Times Staff Writer

Investors have lost their appetite for bonds tied to high-risk mortgages but are holding tight to corporate "junk" bonds and other securities that also are viewed as speculative bets.

That has calmed fears on Wall Street that the turmoil in the U.S. mortgage business would spread, domino-like, through markets worldwide.

Rising homeowner defaults on so-called sub-prime mortgages have caused that industry to implode in recent weeks as investors have balked at buying bonds backed by sub-prime loans.

The jump in defaults means that bond owners are facing the prospect that they won't receive the full interest and principal payments they're owed by sub-prime borrowers, a group that includes people with checkered credit histories.

When that kind of fear zaps one high-risk market it can spread quickly to others, as spooked investors run for cover -- a phenomenon that Wall Street terms "contagion."

This time, investors appear to be betting that the sub-prime woes won't spill over to any great degree into other markets or into the economy overall. Contagion fear "absolutely is not there," said Margaret Patel, manager of the Pioneer High Yield junk bond fund in Boston.

One measure is the yield, or interest rate, on an index of 100 junk bonds tracked by KDP Investment Advisors. Junk bonds are IOUs issued by firms rated below investment-grade quality.

The annualized yield on the KDP index hit an 18-month low of 7.02% on Feb. 26. When global stock markets tumbled that week -- in part because of growing problems in the sub-prime mortgage market -- the KDP index yield briefly jumped, a sign that some investors were dumping the bonds.

But after peaking at 7.26% on March 5, the junk yield has fallen again, to 7.11% as of Monday.

"It wasn't a huge hiccup," said Martin Fridson, head of bond research firm FridsonVision.

Another measure of the relative calm in the junk bond market: The share price of the Vanguard High-Yield Corporate bond fund, a junk fund popular with individual investors, was at $6.27 on Monday, down a mere 3 cents, or less than 0.5%, from its recent peak of $6.30 on Feb. 26.

The prices of bonds of emerging-market economies such as Brazil also were only briefly dented over the last two weeks before buyers returned.

The share price of the Fidelity New Markets Income fund, which invests in IOUs of emerging-market nations such as Brazil and Russia, was at $14.86 on Monday, nearly back to where it stood before the sub-prime worries escalated.

Investors' confidence in other high-risk bonds is a sign that they don't believe the U.S. economy will be slammed by the troubles of sub-prime borrowers. The government's report Friday that the U.S. economy created a net 97,000 new jobs in February was strong enough to allay concerns that the slowdown in the housing market could trigger a recession.

If investors feared that a recession loomed they'd be much warier of junk IOUs, because defaults by junk borrowers would be expected to surge in a contracting economy, Fridson said.

A report last week by bond-rating firm Moody's Investors Service said just 1.6% of junk bonds worldwide had defaulted in the 12 months through February, the lowest in 25 years.

Until the default rate moves up, many investors are unlikely to feel compelled to cut back on junk securities, Fridson said.

As for emerging-market countries, their bonds also are likely to remain in demand until investors believe that the global economic boom is on the wane.

Andrew Brenner, an emerging-markets bond expert at Man Securities in New York, said countries such as Russia and Brazil have become much stronger financially over the last five years than they were in the late 1990s, thanks in part to booming exports of raw materials.

The countries' healthy balance sheets damp concerns that they could face a sudden credit crunch along the lines of what has happened to financially crumbling sub-prime lenders.

Still, Brenner said he believed that bonds of countries such as Brazil didn't offer high enough yields to make them worth the risk of something unforeseen going wrong. A 30-year Brazilian government bond pays 6.44%, compared with 4.70% for a 30-year U.S. Treasury bond. That difference is "too narrow" for his taste, Brenner said.

Some analysts also cautioned that contagion from the sub-prime market might yet develop, if the mortgage industry's problems deepen.

"I'd say it's early," said Jim Keegan, a bond fund manager at American Century Investments in Mountain View, Calif.

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