What are corporate bonds?
Quick Take on Fixed Income
November 2015
Question: What are corporate bonds?
Answer: Corporate bonds are debt securities issued by corporations. The bonds have a maturity greater than one year, and interest income is taxable at local, state and federal levels. These bonds are the obligation of the issuing company, which can issue many bonds with different maturities and characteristics to finance its operations. The bonds are backed by the company’s ability to make interest and principal payments or hard assets used as collateral. The Securities Industry and Financial Markets Association reported that corporations issued almost $1.5 trillion in bonds in 2014.
Credit Quality
Credit rating agencies give companies letter grades based on their financial strength. Each agency has a different approach to rating companies and municipalities to determine credit worthiness. As shown below, corporate bond issuers do not compare favorably to municipal issuers when viewed within the strict buying parameters (Aa3 or higher) of BAM’s Fixed Income Desk, with whom we work to build our clients’ bond portfolios. Municipal bonds also hold their credit rating better than corporate bonds. For example, according to Moody’s data covering 1970–2014, Aa rated municipal bonds hold their rating 95 percent of the time, while similarly rated corporates bonds retain their rating roughly 84 percent of the time. Corporate bonds tend to have lower credit ratings on average and get downgraded more frequently than their municipal counterparts.
Returns
From 1927–2014, corporate bonds on average returned only 0.3 percent more than their Treasury equivalents. High-quality corporate bonds also tend to yield less than brokered CDs to the tune of 10–30 basis points depending on maturity. The small premium for taking on corporate risk, coupled with the lower yields compared with brokered CDs, leads BAM’s Fixed Income Desk to not recommend purchasing corporate bonds. For clients that might require additional return, the equity markets have historically rewarded that risk much better.
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