Credit Market Outlook: Bonds Priced for the Benign

Dave Sekera, CFA

Corporate bond markets are pricing in a benign environment in the U.S. Returns for the remainder of 2014 will be constrained by tight credit spreads and rising interest rates. The spread between financial and industrial sectors holds steady. Are larger LBO transactions coming back? Economic growth in China shows further signs of slowing. Downgrades outpace upgrades during the first quarter.

Corporate Bond Markets Are Pricing in a Benign Environment in the U.S.
Year to date through March 17, the Morningstar Corporate Bond Index has risen 2.37%. However, the preponderance of the return has been driven by declining long-term interest rates as opposed to tightening credit spreads. The recent flight to safety has driven the yields on the 10-year and 30-year Treasury bonds down 33 basis points to 2.70% and 3.63%, respectively. During the same time period, the average credit spread within the Morningstar Corporate Bond Index had tightened to its lowest levels since before the 2008-09 credit crisis, but it has recently widened and is now unchanged for the year at +120.

Among other fixed-income classes thus far in 2014, our U.S. Treasury Index has risen 1.54%, the U.S. Agency Index has increased 0.94%, and our Mortgage Bond Index has gained 1.80%. Declining yields for U.S. Treasuries were been driven by weaker-than-expected economic metrics in the U.S., as the unusually cold weather has disrupted the normal economic activity as well as decreasing inflation expectations. In addition, slowing economic growth and rising corporate bond defaults in China, as well as political turmoil in the emerging markets, specifically in Ukraine, are weighing on investor sentiment.

After reaching new post-credit-crisis tights, the recent widening of credit spreads is very mild compared with the indexes' trading range during the past year. For example, at its current level, the index is still tighter than where spreads backed off to when the turmoil in Ukraine pressured risk-assets in late January. In addition, corporate credit spreads are still significantly tighter than where levels were last summer when the corporate bond market sold off in sympathy with the rise in Treasury rates. Considering that credit spreads are near their tightest levels since before the 2008-09 credit crisis, the takeaway from the current market action is that investors are confident that any potential contagion from Ukraine or economic weakness in China will be extremely limited in the U.S.

Based on a long-term fundamental perspective, we continue to believe corporate credit spreads are fairly valued--albeit at the tight end of the range that we view as fairly valued. Across our coverage universe, our credit analysts generally have a balanced view that corporate credit risk will either remain stable or improve slightly, but that the tightening in credit spreads on those names will likely be offset by an increase in idiosyncratic risk (debt-funded mergers and acquisitions, increased shareholder activism, and so on). However, considering that spreads are already at the tight end of where we think fair value lies, we think there is risk in the near term that spreads could quickly widen if the slowdown in China quickens or contagion from the political turmoil in Ukraine spreads into other former Soviet states or Eastern Europe.

Although the flight to safety has pushed interest rates down, we continue to think that interest rates will rise toward historical norms compared with inflation, inflation expectations, and the steepness of the Treasury curve. While the path the Fed will take to reduce and then finally conclude its asset-purchase program during the course of this year is uncertain, we do expect long-term rates to rise and return to normalized levels by the time the Fed is close to ending its asset purchases. At a normalized level, we think the 10-year Treasury could increase to between 3.25% and 3.75%.

Returns for the Remainder of 2014 Will Be Constrained by Tight Credit Spreads and Rising Interest Rates
In our base-case scenario, the corporate bond market will likely struggle to return much more than its current return for the remainder of 2014. With interest rates poised to rise and credit spreads at their tightest levels since the end of the 2008-09 credit crisis, we expect rising rates to largely offset the current yield corporate bonds currently offer. Even with the increase in interest rates thus far this year, the average yield of the Morningstar Corporate Bond Index is still only 3.07%, not much higher than the lows it hit earlier this year. Based on the current yield and the impact of rolling down the curve, anything greater than about 75 basis points of increase in interest rates would result in losses again in 2014 (excluding any change in credit spreads).

In our opinion, the most likely upside scenario is that corporate bonds produce low-single-digit returns. In this case, we assume that interest rates remain in a narrow trading range and that corporate credit spreads tighten slightly. To generate higher returns than low single digits, one would have to assume that interest rates decline back toward their historic lows (unlikely unless the U.S. were to lapse into a recession) or credit spreads tighten toward their historically tight pre-credit-crisis levels.

In the fall of 2012, we changed our recommendation on corporate bonds to a neutral (or market weight) view from an overweight, as we thought credit spreads were fairly valued based on our outlook for credit risk. During the past 12 months, the average credit spread in the Morningstar Corporate Bond Index has traded in a relatively narrow range between +115 and +167 basis points, averaging +136. In our fourth-quarter 2013 Market Outlook, we highlighted our expectation that corporate credit spreads would be pushed toward the bottom of the trading range by the end of the year. Although we are near the tights, it appears that in the short term, the path of least resistance is tighter still. However, from a fundamental viewpoint, we think that the preponderance of credit-spread tightening has run its course.

Considering that spreads are already at the tight end of where we think fair value lies, we think there is risk in the near term that spreads could quickly widen if interest rates were to quickly rise during the remainder of the year as the Federal Reserve reduces its asset-purchase program. In that case, we would expect a repeat of last summer's chain of events when the 10-year Treasury yield rose about 100 basis points. Corporate credit spreads quickly widened out as portfolio managers looked to sell long-term bonds to reduce duration (a measure of interest-rate sensitivity) and dodge the brunt of losses from rising yields. During those two months, the average spread in the Morningstar Corporate Bond index widened 30 basis points, peaking at +167, its widest level for the year. In addition, if the economic slowdown in China intensifies or contagion from the political turmoil in the Ukraine spreads into other former Soviet states or Eastern Europe, we could see a quick spike in credit spreads as systemic fears return to the forefront. In such an environment, while credit spreads would widen, we expect that a flight to safety would push Treasury bonds up, thus the declining yields would help offset the impact of the wider spreads.

Looking further back, since the beginning of 2000, the average credit spread within our index is +170, and the median is +149. Currently, credit spreads are 40 basis points wider than the lowest levels reached prior to the 2008-09 credit crisis. Even if we exclude the impact of the credit crisis, credit spreads are tighter than the historical average. Excluding the 2008-09 credit crisis, the average credit spread of our index is +147, some 27 basis points wider than where it is now. Although credit spreads may continue to compress slightly, we don't anticipate returning to anywhere near pre-credit-crisis lows. At that time, credit spreads were lower than they should have been, owing to an overabundance of structured credit vehicles that were created to slice and dice credit risk into numerous tranches, artificially pushing credit spreads too low. Once the credit crisis emerged, investors found that many of these vehicles did not perform as advertised. While there have been some reports that a few investors are beginning to re-evaluate investing in collateralized debt obligations, we doubt that these structures will re-emerge anytime soon in any kind of meaningful size.

During the long term, we expect interest rates to normalize toward historical metrics. Three of the metrics we watch include the spread between current inflation and interest rates, inflation expectations, and the steepness of the Treasury curve. Historically, the yield on the 10-year Treasury bond has averaged 200-250 basis points during a rolling three-month inflation rate. Even with inflation running at an average 1.4% during the past three months, the yield on the 10-year Treasury could increase to 3.25%-3.75% to reach historical norms.

Although we expect interest rates to normalize at higher levels as asset purchases decline, we are not overly concerned that the rise in long-term interest rates will overshoot too much above our estimates. Currently, the spread between the 2-year and 10-year Treasury bond is near its historically widest levels. Because the 2-year bond is highly correlated to short-term interest rates and the Federal Reserve is planning on keeping the federal-funds rate near zero until sometime late in 2015, the yield of the 2-year Treasury bond should be well-anchored. Based on where this spread has historically peaked, the 10-year yield could increase another 50 to 60 basis points over the 2-year before beginning to breach its prior ceiling. With the Fed pledging to keep short-term rates near zero until late 2015, we think the 2/10s curve can return back to its widest levels.

After peaking in November 2012--a few months after the most recent quantitative easing program had been launched--market-implied inflation expectations have been generally declining and took a sharp leg down once the Fed officially announced it would begin tapering its purchases. With inflation expectations, based on the five-year/five-year forward break-even measure, dropping toward the lower end of the trading range since the credit crisis, this should also moderate the rise in rates.

Spread Between Financial and Industrial Sectors Holds Steady
The spread between the financial and industrial sectors within the Morningstar Corporate Bond Index held steady during the first quarter. The results of two U.S. bank sector stress tests are under close watch this month: The Federal Reserve's Dodd-Frank stress test was released March 20, and the Comprehensive Capital Analysis and Review (CCAR) had a March 26 release. Although we do not expect negative surprises involving the banks on our coverage list, we do expect the Fed will continue to restrict the amount of capital that the large banks can return to shareholders, a positive development for bondholders.

Historically, credit spreads for the financial sector traded tighter than the industrial sector. Currently, the spread is between the sectors is 9 basis points, whereas before the credit crisis, the average spread differential was 40 basis points and had traded as wide as 112 basis points. While we don't expect the spread differential to return back to the historic wides, we do think that the financial-services sector will outperform in a low-volatility world where idiosyncratic risk is of greater concern than systemic risk. The caveat is if the incipient corporate credit defaults in China begin to snowball into a full-blown credit crisis in the country, which could then spread to and pressure other global banks that have significant Chinese exposure.

After suffering the ignominy of suffering as being the worst performing sector in 2013, the media sector rebounded in the first quarter of 2014, outperforming the general market by 26 basis points. The outperformance last quarter was predominately due to Time Warner Cable (TWC) (rating: BBB-, wide moat), which agreed to be acquired by highly rated Comcast (CMCSA) (rating: A-, wide moat). For example, TWC's 4% notes due 2021 tightened to +129 basis points from +305 basis points. Last quarter we stated our belief that TWC bonds presented a compelling risk/reward proposition, trading as if an acquisition by highly leveraged Charter Communications (CHTR) (not rated) and a resulting move to high-yield was a foregone conclusion. We now believe TWC bonds are fairly valued.

Credit Risk Outlook Appears Benign in Short Term, but Risks Remain
While risks to the corporate bond market appear benign, there are several threats to the downside lurking. With credit spreads already at lower-than-average levels and interest rates near historic lows, portfolio managers will need to be especially nimble in 2014 to outperform. In 2014, successful portfolio managers will need to carefully time when to reach for yield to capture additional carry to outperform their index, but they will also need to keep one finger above the sell button to reduce risk when events warrant lower credit risk exposure. Although volatility is currently very low, when markets correct to the downside, they rarely correct in a gradual fashion, but rather correct in a step function.

Throughout 2013, we have highlighted that idiosyncratic risk leading to downgrades and issuer-specific credit-spread widening was the greatest threat to corporate bond investors. Considering Robert Johnson, our director of economic analysis, expects gross domestic product growth in 2014 between 2.0% and 2.5%, we don't foresee a material increase in defaults or cash flow compression resulting from a recession which could push spreads wider.Therefore, we expect idiosyncratic credit risk to once again be the greatest determinant of differentiated portfolio returns. Perversely, as interest rates rise, a few elements of idiosyncratic risk diminish. For example, higher all-in yields on corporate bonds compared with dividend yields will make debt-funded share buybacks become less attractive. As equity prices reach new highs, the combination of highly valued share prices and increasing interest rates may also damp the amount of debt that a firm may utilize in pursuing strategic acquisitions and limit the attractiveness of split-offs and spin-outs.

Are Larger LBO Transactions Coming Back?
Safeway (SWY) (rating: UR-/BBB, no moat) recently announced it has reached an agreement to sell itself to AB Acquisition, the owner of the Albertson's family of supermarkets, which itself is owned by an investor group led by Cerberus. AB Acquisition plans to fund the merger in part with debt financing of approximately $7.6 billion, equity contributions from its current investors of approximately $1.25 billion, and cash on hand of Safeway. Based on the size of the deal and amount of financing required, this is the largest leveraged buyout since Heinz was bought a year ago and Dell's leveraged buyout was completed last fall. Therefore, this is an excellent opportunity for the private equity community to test the appetite of the banks to provide hefty commitment letters to fund large LBOs.

Even though the economic recovery is still only growing at historically low rate, that hasn't slowed down the private equity sponsors, who are in the midst of raising record amounts of capital that needs to be put to work. In 2013, according to Preqin (a data provider for the alternative asset class), private equity funds have increased their amount of dry-powder by 14% to more than $1 trillion, an amount slightly higher than the previous high registered at the end of 2008. However, according to Preqin, the value of buyout investments only averaged $264 billion during the past three years.With over $1 trillion of capital looking to make acquisitions, it has raised concerns about the ability of these private equity funds to be able to put this amount money to work, thus potentially leading to larger deals.

In addition to the record amount of equity capital to support a resurgence of large LBOs, the market for collateralized loan obligations has also staged a resurgence in 2013. In order to launch the new CLOs, fund managers have been scrambling to purchase loans to fill their warehouse lines and are willing to purchase loans made at higher debt leverage and with fewer protections for investors. For example, the percent of first-lien loan volume that is covenant-lite has risen to more than 90%, significantly higher than the proportion of covenant-lite deals during the heyday in the mid-2000s. Considering most private equity sponsors were busy harvesting gains in 2013 by selling down equity stakes among their portfolio companies, with record dry-powder available and easy terms in the bank debt market, a successful LBO and financing of Safeway could be the catalyst to set off a new round of buyouts.

Economic Growth in China Shows Further Signs of Slowing
In addition to recently suffering its first onshore public corporate bond default, economic metrics in China are indicating that economic growth is slowing. For example, China's exports unexpectedly fell by over 18% in February compared with last year, though much of the blame was apportioned to the shift in timing of the Lunar New Year holiday. Multiple other recently released economic indicators continue to suggest rapid growth, yet the growth rates are rising at some of their slowest paces in years. Fixed asset investment, which measures the infrastructure spending that has been China's economic backbone, increased 17.9% during the first two months of 2014. While this rate of growth would be remarkable in the developed markets, this rate was actually the slowest increase in China since 2002. In addition, industrial output increased 8.6% in January and February compared with last year, but this growth rate was the lowest rate since April 2009. Similarly, retail sales increased 11.8% during the same time period, but was the lowest rate of increase since February 2011.

Slowing growth in China is having an adverse impact within the commodities markets. For example, copper (also known as "Doctor Copper" due to its historical ability to diagnose economic health or sickness) has dropped precipitously since the beginning of the month. The price per pound has fallen to less than $3/pound compared with $3.20/pound at the end of February and compared with more than $3.50/pound this time last year. In addition to being the largest consumer of copper, copper has reportedly been used as collateral in China's shadow banking system.

China's policymakers appear to be beginning to publicly admit that growth may be slower than the country's official goals for 2014. For example, China's finance minister was recently quoted as stating that GDP growth of 7.2% in 2014 would be "about" the 7.5% growth rate that officials had publicly targeted earlier. Similar to the goals of other policymakers across the globe, he has taken the position that the government's focus is on employment, as opposed to just economic growth alone. This wording suggests to us that the government will allow slower-than-desired growth so long as the labor markets are not too adversely affected by the reduced pace.

Although the size of the current bond defaults are de minimus relative to the overall size of the Chinese financial system, it's not the size of the defaults that is concerning, but what it might be indicative of. The worry is that this is a harbinger of many more defaults yet to come and in greater principal amounts. Previously, the Chinese banks and government have supported the bond and loan market by rolling over or extending maturing debt of those firms that were not able to otherwise repay or refinance. It now appears that the Chinese government is going to allow at least some amount of issuers to default. We suspect that the Chinese government will endeavor to allow small deals to default which can be written off by the banking system, but it will continue to support those issuers whose deals are large enough to potentially cause systemic financial issues. If the government successfully allows some debt to default but restrains the default rate from rising too far or too quickly, it should help brake the rapid rise in corporate debt. Total corporate debt outstanding has grown substantially faster than GDP in China during the past five years and is reportedly 125% of GDP, having grown from 92% of GDP in 2008.

Downgrades Outpace Upgrades During the First Quarter
After experiencing the strongest rate of upgrades over the course of our rating history during the fourth quarter of 2013, the pattern reversed course as the pace of downgrades outpaced upgrades in the first quarter of 2014. Among the upgrades, Cardinal Health's (CAH) (rating: A, wide moat) improvement was driven by our upgrade of the company's economic moat to wide from narrow. Our other upgrades included Weyerhaeuser (WY) (rating: BBB-, no moat), Pioneer Natural Resources (PXD) (rating: BBB, narrow moat), and Masco (MAS) (rating: BB+, no moat), which were mainly driven by a reassessment of our forecasts for each of the company's financial prospects and positive improvement in their credit metrics.

Among the downgrades last quarter, we reduced our ratings on three global banks, Credit Suisse (CS) (rating: A, narrow moat), Deutsche Bank (DB) (rating: A-, narrow moat), and JPMorgan Chase (JPM) (rating: A-, narrow moat), due to lower profitability and higher leverage relative to many global peers. While the regulatory capital levels at these banks appear solid, the main impetus for the downgrades was predicated on lower tangible common equity and Tier 1 leverage relative to higher-rated peers.

The remaining downgrades for AK Steel (AKS), Kellogg (K), ADT (ADT), and Bombardier (BBD.B) were driven by results that were weaker than our expectations and prompted our analysts to reassess their long-term projections for those firms. For example, we updated our forecast for AK Steel that the company will continue to burn cash in 2014 and 2015, requiring increased borrowing under its bank facility and placing additional pressure on overall liquidity. Kellogg's margins and credit metrics have underperformed our assumptions since we originally rated the issuer, and we revised our expectations preclude Kellogg from repaying debt as quickly as we had originally modeled after the Pringles acquisition

In August 2013, we downgraded ADT (ADT) (rating: BB, narrow moat) to below investment grade following management's announcement that it will adopt a more shareholder-friendly capital structure by increasing its leverage target to 3 times from 2 times. That move had come roughly eight months after management had increased its leverage target to 2 times. Last quarter, we downgraded ADT once again after we reduced our economic moat rating to narrow from wide, increased our fair value uncertainty rating to high from medium, and substantially reduced our five-year financial projections.

Sector Updates and Top Bond Picks

Basic Materials
Metals prices, led by copper and iron ore, have taken a beating in the past few weeks. Iron ore dropped from $135 per metric ton to begin the year down to $104.70 on March 10. Meanwhile, copper dropped below $3 per pound, marking the first time since July 2010, and more than 10% below the start of the year. Multiple proximate causes have been identified to explain the sudden plunge in prices for these key metals. For iron ore, some cited the recent default by a Chinese steel mill, privately owned Haixin Steel. For copper, traders blamed a Chinese government crackdown on copper financing deals, a major conduit for cheap, hot-money U.S. dollar-denominated loans to gain entry to China's supposedly closed capital account. China's weak February export data, while muddied by over-invoicing and Chinese New Year anomalies, didn't help matters for either metal. Nor did the recent bond default by Chaori Solar. We do not believe the recent weakness in these commodities is a trough, but rather a slide. We expect prices will continue to fall as the market comes to terms with China's economic rebalancing. As a result, our preferred mining exposures remain moat-worthy low-cost producers, such as Vale (VALE) (rating: BBB+, narrow moat). We expect Vale's profits to remain robust even as it brings on significant new supply, due to its very attractive position on the industry cost curve. By contrast, we continue to recommend avoiding high cost producer Cliffs Natural Resources (CLF) (rating: BB+, no moat) as we see these trends putting continued pressure on its bonds.

U.S. price trends for thermal coal have been positive through the beginning of 2014. Since the end of 2013, Western Rail Powder River Basin coal swaps have gained 4% to over $12 per ton. We believe PRB coal will carry this positive momentum into the year, with pricing expected to continue to strengthen amid higher natural gas prices and increased coal burn. This is in contrast with our outlook for metallurgical coal which continues to suffer from global overcapacity. Among thermal coal producers, we favor PRB pure-play Cloud Peak Energy (CLD) (rating: BB+, narrow moat) which maintains a favorable cost structure and the strongest balance sheet among its peers.

The global potash market looks like it could be close to turning a corner with a more normalized demand environment expected in 2014, the increasing likelihood that the cartel-like marketing organization between Uralkali and Belaruskali will reform, and what looks to be a near-term bottom in potash prices. Phosphate prices are also on the mend with a big increase in spot prices that started at the beginning of 2014. We believe price appreciation will boost the fortunes of recommended overweight Mosaic (MOS) (rating: BBB+, no moat), the largest phosphate producer in our coverage universe, which recently acquired the phosphate operations of CF Industries (CF) (rating: BBB-, no moat).

Contributed by Dale Burrow, CFA

Consumer Cyclical
With tepid expectations for retail sales, we are remaining on the sidelines for the preponderance of the consumer cyclical names on our list, and have a market weight stance. However, many management teams appear optimistic on earnings growth and are opting to deploy more capital toward dividends and share repurchases, in most cases, issuing debt to fund these activities. Lowe's (LOW) (rating: A, wide moat) and O'Reilly Automotive (ORLY) (rating: BBB, no moat) are two such names, having ended the most recent quarter just inside their respective leverage targets. Lowe's projected share repurchases of $3.4 billion, and dividends of $700 million exceed estimated 2014 free cash flow of $2.9 billion. Accordingly, we would expect Lowe's to tap the debt markets. O'Reilly's management recently stated that it does plan to issue debt during 2014, and we expect the debt to fund share repurchases as the firm added $500 million to its share repurchase authorization.

Also, as we stated last quarter, we are closely watching acquisition activity. This quarter brought us one acquisition in our space, and we expect to see more. Mattel (MAT) recently announced the acquisition of Mega Brands for $460 million, which includes the assumption of debt, and plans to issue $500 million in new debt. We estimate pro forma leverage, accounting for Mega's EBITDA contribution, would rise to roughly 2 times from 1.7 currently. However, we note that this excludes potential synergies. We believe this is within the current rating of A-, but believe other firms may sacrifice their credit rating for an acquisition.

Wal-Mart (WMT), however, has recently affirmed its commitment to its AA credit rating in light of softer earnings, shareholder-friendly activities (the firm recently raised its annual dividend by just over 2%), and the potential for acquisitions. We believe the firm could face several challenges during the next few quarters (macroeconomic conditions, harsh weather, cuts to food-stamp benefits, and aggressive price investments), but we think this wide-moat company's cost advantage should allow it to defend its competitive position. Lease-adjusted leverage continues to be maintained around 1.8 times. We currently view bonds as undervalued. The firm's 2023 notes are trading not only wide of Morningstar's AA Industrials Index, but also wider than the more cyclical name McDonald's (MCD) (rating: AA-, wide moat), which we rate one notch lower.

Contributed by Joscelyn MacKay

Consumer Defensive
For the sector, we expect sales growth will only marginally exceed nominal GDP growth rates and operating income growth will range in the mid- to high-single digits. With organic growth opportunities sluggish and cash balances building, management teams are increasingly feeling the pressure to deploy capital and we expect companies will continue to pursue strategic mergers and acquisitions. However, we expect that most transactions will be centered on smaller, strategic acquisitions rather than large, transformational or private equity sponsored deals. Firms will likely continue putting excess cash to use by building out their distribution platforms at home and abroad, and pursuing smaller, bolt-on transactions.

Attracted by strong balance sheets, high cash balances, and solid operating margins, shareholder activists are becoming increasingly active in the consumer defense sector. For example, activist investor Nelson Peltz's investment vehicle, the Trian Fund, has taken a large position in PepsiCo (PEP) (rating: AA-, wide moat) and publicly advocated several alternatives for Pepsi to increase shareholder value. Given Trian's holdings of both Pepsi and Mondelez (MDLZ) (rating: BBB, wide moat), rumors circulated that Pepsi may acquire Mondelez. That rumor died down after Peltz's push failed to gain traction (however, he did gain control of a board seat at Mondelez). Since the initial discussions, PepsiCo has conducted a strategic review of its business and has decided that it would increase its dividend and share buybacks, but will remain as one entity. PepsiCo's CEO, Indra Nooyi, has stated numerous times that she believes the company garners significant synergies and benefits from the combined beverage and snacks business (each account for roughly half of the firm's revenues). In our opinion, she has been so emphatic that the company creates greater shareholder value as a combined entity, that so long as she is CEO the company will remain intact. However, if she resigns (either willingly or forced out by the board of directors) during the next few years, we think that would be a sign that the company will be broken up.

Our issuer credit rating on PepsiCo is one to two notches higher than the rating agencies. The rating differential is most likely based on our assessment that the firm has a wide economic moat and our projections that the firm will continue to maintain very strong credit metrics. The firm's wide economic moat is derived from its direct store delivery system, global scale, and strong brands which dominate the snack business. However, if the firm were to split itself in two, in our downside scenario for bondholders, we estimate the credit rating would fall at least several notches to mid- to low-single A.

Contributed by Dave Sekera, CFA

Energy
Our first-quarter outlook focused on natural gas price volatility, crude price differentials in the U.S., and concerns about a cyclical downturn in the offshore drilling market. Volatility in the price differential between West Texas Intermediate and Brent crudes has abated which contributed to the spread tightening in the refining sector which we predicted would occur in the first quarter. We project that differentials will remain relatively stable going forward, and with spreads already reflecting our long-term view, see limited opportunity for further outperformance in the refining sector.

Although the spot price of natural gas has retreated after peaking above $6 per thousand cubic feet, replenishment of depleted storage volumes should help support prices through the low-demand springtime period. Natural gas storage level of 1,001 billion cubic feet, as of March 7, is almost 50% below the 2013 level at this time, and 46% lower than the five-year average level. Offsetting this positive data point, natural gas production volumes have remained stubbornly high and are on an upward trajectory. While we have a positive view of industrial and power generation demand in the long-term, these sources of incremental demand will not grow fast enough to offset production gains in the near-term. As a result, natural gas futures strip prices are lower today than six months ago when storage levels where near their five-year average. In general, E&P spreads performed with the market in the first quarter, and with the price of both crude and natural gas likely range bound in the near-term, we anticipate more of the same in the second quarter. We continue to favor Cimarex (XEC) (rating: BBB–, narrow moat) whose continued risk-adjusted outperformance relies primarily upon the company's consistent execution of its drilling program.

Spreads of offshore drillers underperformed the market in the first quarter as in-line fourth-quarter results were overshadowed by cautious statements regarding the 2014 outlook. Coming into the first quarter, we recommended investors exercise caution as the long-term outlook for day rates was less certain than it was at the start of 2013. Since that time, several data points, including lower day rates for rigs bid into Petrobras' (PBR) and warnings from Transocean (RIG) and Noble (NBL) about deteriorating terms across the industry, reinforced our thesis. Currently, we expect a difficult 18 to 22 months as the market adjusts to the surge of new deepwater rigs that are scheduled to be delivered. Despite the spread performance in the first quarter, we continue to believe that spreads will underperform the broader market as incremental data points are unlikely to signal an improvement in pricing.

Contributed by David Schivell

Financials
Banking Sector
In our last quarterly credit outlook, we highlighted the significant improvement in credit quality trends the overall banking sector has experienced since the depths of the Great Recession. Many of our favorite names like Citigroup (C) (rating: A-, narrow moat) and U.S. Bancorp (USB) (rating: A+, narrow moat) saw nearly 30% reductions in credit loss provisions during 2013, providing material support to earnings. Given our expectation for continued moderate levels of economic growth in the second quarter of 2014 and few surprises from the Fed, we see minimal changes in the interest-rate environment which should keep net interest margins and mortgage income at subdued levels while minimizing the negative mark to market effects on bank's security holdings. But the environment should also be supportive of credit-quality trends. We expect provision expense and charge-offs to remain near current levels in the second quarter of 2014. As a result, we expect less benefit to bank earnings in the future than seen in prior periods.

The results of two U.S. bank sector stress tests are under close watch this month: The Federal Reserve's Dodd-Frank stress test was released March 20, and the Comprehensive Capital Analysis and Review (CCAR) had a March 26 release. Both tests are forward-looking and attempt to assess whether an institution has adequate capital to absorb losses and support operations during adverse economic and financial market conditions. While we do not expect negative surprises involving the banks on our coverage list, we do expect the Fed to restrict the amount of capital that the large banks can return to shareholders, a positive development for bondholders.

In Europe, however, the trends haven't been as clear. Certain global stalwarts like HSBC Holdings (HSBC) (rating: A+, narrow moat) with diverse revenue sources and low-cost deposit funding sources were able to overcome the weak European economy in 2013 by growing earnings 16.2% due largely to a 29.6% drop in loan loss provisions. Other banks like Deutsche Bank (DB) (rating: A-, narrow moat) appeared to preparing for the European Central Bank's Asset Quality Review later in 2014 by increasing provisions for loan losses, leading to a loss for the quarter and a measly 1.9% return on equity for the year. We generally expect European banks to improve their balance sheets and capital buffers leading to improved credit metrics during the coming quarters. Broadly speaking, the stress tests should lead to higher capital levels and improve transparency, both of which are supportive of credit fundamentals and spreads for the sector.

Insurance Sector
Companies in the U.S. insurance sector continue to strengthen balance sheets weakened by the financial crisis indicating a better ability to withstand loss events and macroeconomic uncertainty. Rising equity markets, good sales, and underwriting discipline have contributed to good earnings for the sector, while the prolonged period of low interest rates has been a modest negative for many life insurance companies with guaranteed rate products. With a modest uptick in interest rates and indications that they will rise further longer term, earnings for insurers are likely to follow. Those that will benefit most are the ones that have a product mix that is skewed toward spread-based products. Rising rates are also expected to improve balance sheet quality as those insurers that have sought higher yields by seeking alternative asset classes and lower quality assets will likely return to high-quality corporate securities.

Shorter term, we expect the effect of the especially cold and snowy winter to have an impact on Property/Casualty insurers first-quarter results. Companies like Allstate (ALL) (rating: BBB, narrow moat) and Chubb (CB) (rating: A, narrow moat) have already indicated that losses in January and February of this year relative to prior winters are significant. We don't believe that this season alone will materially weaken P/C insurer, but credit quality may be impacted if the year produces multiple large loss events.

Contributed by Chris Baker, CFA, and Manish Patel

Health Care
Three key factors--the Affordable Care Act, the patent cliff, and low M&A value-creation hurdles--are encouraging health-care firms to return cash to shareholders and make acquisitions, which can cut into credit profiles. In 2014, we see downside risks at health-care service providers and managed-care organizations due to the Affordable Care Act. Near-term growth hiccups could cause management teams to increasingly use share repurchases or dividends to appease shareholders during this weak period. For example, Bond to Avoid Cigna's (CI) (rating: BBB-, no moat) weak 2014 outlook likely will require significant share repurchases to achieve.

The patent cliff is constraining growth at large pharmaceutical firms. We believe AstraZeneca (AZN) (rating: AA-, wide moat), Eli Lilly (LLY) (rating: AA, wide moat), and Pfizer (PFE) (rating: AA, wide moat) have the weakest fundamental outlooks in this niche and, therefore, the most incentive to pursue capital-allocation activities that cut into their credit profiles going forward. Also, Bond to Avoid Mylan's (MYL) (rating: BB+, narrow moat) internal growth prospects remain slow due in part to a key patent expiration in 2015. However, Mylan has issued an aggressive five-year plan, which we believe is only possible with acquisitions and share repurchases; those potential catalysts could cause the agencies to capitulate on their BBB-/Baa3 ratings eventually.

With historically low interest rates, tax-advantaged domiciles, and valuable equity currencies at their disposal, specialty pharmaceutical firms may remain active on the M&A front. While M&A events are notoriously difficult to predict, Valeant Pharmaceuticals (VRX) (rating: BB, narrow moat) appears likely to make a move that could shake up the industry with its goal of becoming one of the top five most valuable pharmaceutical companies by the end of 2016. Any hope of reaching that goal will depend on completing a merger of equals, which could have dire consequences for bondholders of merger targets. Specifically, we highlight Abbott Laboratories (ABT) (rating: AA-, narrow moat), Allergan (AGN) (rating: AA-, wide moat), Teva Pharmaceutical (TEVA) (rating: A-, narrow moat), and Zoetis (ZTS) (rating: BBB+, wide moat) as key potential targets. Their credit ratings could fall severely in a merger scenario. Even without a merger, we believe Abbott and Teva possess negative credit outlooks due to their weak growth prospects and openness to acquisitions and returns to shareholders.

Contributed by Julie Stralow, CFA

Industrials
For the second quarter we are looking for a recovery in some of the consumer-driven Industrials subsectors which have been impacted by the brutal winter. The auto sector domestically has posted relatively flat sales for January and February, which compares to our expectation of a SAAR of 15.9 million-16.2 million units for 2014 versus 15.6 million last year. We also see the homebuilding sector, fully dependent on the domestic market, improving as pent up demand persists.

There have been a mixed set of signals out of the homebuilding sector. The list of negative data points including sliding homebuilder sentiment, lackluster starts and permits data for new construction, and softer existing home sales. Adding to this was Toll Brothers (TOL) (rating: BBB-, no moat) management on a recent earnings call commenting on the flat activity in most of its markets. We believe weather has been a meaningful factor and the spring selling season will eventually emerge with stronger sales activity. This could emerge in upcoming earnings calls from other builders. We also note positive factors including pricing growth which continues and inventory levels which remain quite low. We see the sector as generally fairly priced but continue to point investors to Toll, which provides "BB"-like spreads despite our investment-grade rating. We see this name as a potential rising star (Moody's and S&P are a notch below investment grade) during the next year or so.

For the auto sector we see steady domestic growth combined with mixed international conditions bringing a net positive fundamental backdrop. We are encouraged that North American light-vehicle production through March 1 is roughly flat due to most major automakers, except General Motors (GM) and Chrysler, reducing output due to high inventory. GM reported its U.S. inventory down to an 87 days supply from 114 at the end of January while Ford (F) reported 91 days from 111. Ideally we want those levels to be closer to 60 days but we are confident that there is pent-up demand and that the industry is not done recovering from its 2009 bottom of 10.4 million vehicles sold. Favorable new vehicle sales on top of strong recurring parts and service revenues continue to support the dealers, and AutoNation (AN) (rating: BBB-, narrow moat) should show strong results. Globally, we are encouraged by Europe's fifth straight month of increasing new car registrations and see this market as providing stability to the OEMs and suppliers.

The wild card remains South America, and we expect this to remain challenging. All in all, we believe there could be select positive ratings actions at the OEMs over the next few quarters. The suppliers are generally in even better shape given good underlying OEM demand combined with ongoing regulatory trends supporting safety, connectivity, and green technologies, which are boosting backlogs substantially. However, the ratings agencies have generally caught up to our ratings and we see mostly fair valuations outside of BorgWarner (BWA) (rating: A-, narrow moat), which provides investors who can find the bonds spreads in the BBB range.

Finally, increasing share repurchase and dividend initiatives are on our radar screen across much of the rest of industrials. For the defense sector, a sharp increase in shareholder-friendly initiatives has been driven by greater visibility in defense spending and the impacts of sequestration along with a sharp reduction in pension liabilities and funding levels. We see this as remaining balanced to keep credit quality stable, though spreads remain generally tight. We believe M&A activity could also pick up with the greater confidence at management teams although we are not looking for any blockbuster deals. Our only investing idea in the space remains Alliant Techsystems (ATK) (rating: BB+, narrow moat), which we expect to steadily deleverage over the next few quarters after a recent acquisition.

Contributed by Rick Tauber, CFA, CPA and Basili Alukos, CFA, CPA

Technology and Telecommunications
Telecom and technology sectors continued to grind tighter over the past quarter, both in absolute terms and relative to the Morningstar Industrials Index. Time Warner Cable was the sectors' biggest winner, with its 4.0% notes due 2021 moving to +129 basis points to the nearest Treasury from +305 basis points on Comcast's move to acquire the company.

Last quarter we stated our belief that TWC bonds presented a compelling risk/reward proposition, trading as if an acquisition by highly-leveraged Charter Communications and a resulting move to high-yield was a foregone conclusion. We now believe TWC bonds are fairly valued, appropriately reflecting the potential that the proposed Comcast deal fails to pass regulatory muster. We expect that politicians, not only regulators, will weigh in on the transaction. Debate will likely center around the level of concentration the U.S. is willing to allow among media and telecom infrastructure assets. If the Comcast deal fails, we would expect Charter to renew its pursuit of TWC.

Both AT&T (T) (rating: A-, narrow moat) and Verizon's (VZ) (rating: BBB, narrow moat) have been in the debt markets recently, issuing a range of maturities. AT&T priced 3.9% notes due in 2024 at +125 basis points over Treasuries in early March, while Verizon placed 4.15% notes due in 2024 at +140 basis points a few days later. Spreads on the two bonds have moved closer to each other, with the AT&T issue trading at about +130 basis points and Verizon trading at about +138 basis points. While we believe both bonds look attractive in absolute terms, we view AT&T as far more attractive. The Verizon bond should trade about 30 basis points wide of AT&T based on our view of the differential between the firms' current financial positions. We believe AT&T already has metrics worthy of an A- rating, while we expect Verizon will need three years or more to bring its leverage back into the range typical for an A- issuer. In addition, with Vodafone's (VOD) (rating: BBB+, narrow moat) decision to acquire Ono, the largest cable television operator in Spain, we believe an AT&T bid for Vodafone looks increasingly unlikely.

Across the tech industry, we don't see good value in many places. We removed Hewlett-Packard (HPQ) (rating: BBB+, narrow moat) and KLA-Tencor (KLAC) (rating: A+, wide moat) from our Investment Grade Best Ideas list for institutions, as the bonds of both firms continued to move tighter. We replaced these firms with Juniper Networks (JNPR) (rating: A, narrow moat), which we view as a special situation. Activist investor Elliot Management has pushed Juniper to bump up share repurchases and initiate a dividend, clearly a negative for creditors. However, Elliot has also prodded Juniper to cut costs and refocus operations on its strongest businesses. With more than $4.1 billion in cash and investments on hand, we believe Juniper can fund shareholder returns and maintain a solid financial profile. The firm's recently issued 4.5% notes due in 2024 have traded recently at +173 basis points, which we view as very attractive for the risk.

Contributed by Mike Hodel, CFA

Utilities
Two Environmental Protection Agency regulations continue to cloud the sector's near- to medium-term landscape. Coal plant retirements and increased capital investment are two likely outcomes from final versions of the EPA's Cross-State Air Pollution Rule and the air toxics rule, or MATS (finalized in December 2011). In 2013, the EPA updated stringent emission limits affecting new coal- and oil-fired power plants, effectively killing any economic incentive to build new coal plants in the U.S. While CSAPR was fully vacated in 2012 and the U.S. Court of Appeals (D.C. Circuit) denied the EPA's petition for a rehearing in January 2013, the U.S. solicitor general in March 2013 petitioned the Supreme Court to review the D.C. Circuit's decision. In June 2013, the Supreme Court granted the U.S. petition to review the Circuit Court's decision, and in September 2013, the U.S. filed its opening merits brief. The solicitor general's request specifically addresses whether the court of appeals lacked jurisdiction, whether states are excused from adopting state implementation plans, and whether the EPA interpreted the statutory term "contribute significantly" correctly regarding air pollution contributions from upwind states. We believe these two rules are likely to raise costs for consumers and place increased rate pressure on regulated utilities. Additionally, we believe President Obama will provide continued support for carbon emission and renewable energy regulations as outlined in, "The President's Climate Action Plan."

Despite environmental compliance risks, we continue to view fully regulated utilities as a defensive safe haven for investors skittish about ongoing domestic and eurozone induced market volatility. As economic and geopolitical uncertainties begin to fade in 2014, we expect moderate spread contraction, particularly down the credit-quality spectrum. However, given historically tight parent company spreads on higher-quality utilities facing lackluster growth, we continue to urge bond investors to approach investment-grade utilities with caution. We advise investment-grade utility investors to focus on shorter- to medium-term durations, as Treasury rate increases in 2014 could quickly erode spread outperformance, given historically tight trading levels. Moreover, we believe investors seeking yield should tread lightly when considering opportunities within diversified utilities. We believe elevated downgrade risks exist, given continued weakness at unregulated genco subsidiaries, and specifically highlight FirstEnergy (FE) (rating BBB-, narrow moat) as a possible source of concern in 2014.

We expect high-quality, fully regulated utility issuers to maintain their elevated pace of debt market issuance into the second-quarter 2014, taking advantage of low rates to refinance or prefinance maintenance, environmental, and rate base growth capital investments. However, the timing of debt-funded environmental capital expenditures will remain highly dependent on the severity of ongoing regulatory rulings, implementation timelines, and energy-efficiency initiatives. Finally, we believe utilities are eager to secure financing ahead of further Federal Reserve stimulus tapering in 2014.

Unregulated independent power producers continue to face high uncertainty in 2014. Power prices will remain severely strained as long as natural gas prices remain low. Excess natural gas supply and an unseasonably warm 2013-14 winter could push gas prices, currently hovering around the $4.41/mmBtu mark, back down to 2012's historic lows ($1.91/mmBtu). While we maintain our $5.40/mcf midcycle gas price estimate going into 2014, we recognize that independent power producers' margins will continue to experience pressure over the near-medium term. On the other hand, we note moderately declining natural gas storage levels, totaling 1,001 billion cubic feet (as of March 7), are now 46% below their five-year average of 1,859 billion cubic feet (and down 49% year over year). Moreover, we believe coal prices will generally remain under pressure in 2014 as myriad environmental regulations stymie coal demand.

We continue to expect stand-alone and embedded merchant power producers (within diversified utilities) to experience elevated liquidity constraints, particularly power producers that own uncontrolled coal plants as well as those that have substantial leverage. Specifically, we believe Energy Future Holdings (formerly TXU Corp.) will file for Chapter 11 bankruptcy, likely by the end of the first-quarter 2014 due to an insolvency breach, creating one of the largest bankruptcies in U.S. history (about $47 billion of debt). We also believe Ameren's (AEE) (rating: BBB-, narrow moat) sale of its merchant Energy Resources Generating Company to Dynegy (DYN) reflects the changing utility landscape (that is, reduced diversified utility operators) despite our belief that select coal generation should garner much higher asset values in the future (dollar per kW).

While we expect company-level M&A activity to moderate in 2014, we anticipate robust renewables deal activity to fuel the ongoing creation and expansion of industrywide Yieldco structures. Given high demand-for long-term contracted renewable assets (via PPAs), we highlight independent power producer NRG Energy's (NRG) (rating: BB-, no moat) expected late first-quarter 2014 acquisition of Edison's (EIX) (rating: UR+/ BBB-, narrow moat) merchant subsidiary, Edison Mission Energy (EME), out of bankruptcy for $2.6 billion (EME's Plan of Reorganization was approved by the U.S. Bankruptcy Court March 11 permitting the sale to NRG). Moreover, we expect continued renewables deal activity to fuel the growth of TransAlta Renewables and to support the development of NextEra Energy's (NEE) (rating: BBB+, narrow moat) anticipated Yieldco structure in mid-2014.

Contributed by Joseph DeSapri

Our Top Bond Picks
We pick bonds on a relative-value basis. Typically, this means comparing a bond's spread with spreads on bonds that involve comparable credit risk and duration. Following is a sample of a few issues from our monthly Best Ideas publication for institutions.

When selecting from bonds of different maturities from a single issuer, we weigh a variety of factors, including liquidity, our moat rating (we're willing to buy longer-dated bonds from a firm with sustainable competitive advantages), and our year-by-year forecast of the firm's cash flows in comparison with the yield pickup along the curve.

Top Bond Picks
Data as of Mar. 19, 2013.
Price, yield, and spread are provided by Advantage Data.

Celgene (CELG) (rating: A, narrow moat)
Maturity: 2023
Coupon: 4.00%
Price: $101.75
Yield: 3.78%
Spread to Treasuries: 118
We believe significant spread tightening is possible in Celgene's notes if the firm can diversify its product portfolio beyond multiple myeloma blockbuster Revlimid, which represents about 65% of sales. Positively, we continue to see product-related catalysts on the horizon in the near term. With a more diverse product portfolio, we believe Celgene's 2023s would trade closer to other A rated pharmaceutical peers, AbbVie and Amgen, which have 2022s indicated around 90 basis points over the nearest Treasury. In the near term, we see diversifying potential in Celgene's Pomalyst, a potential multiple myeloma blockbuster, which remains in early commercialization and is growing rapidly. Also, Abraxane continues to expand swiftly in new indications. Another potential blockbuster, Otezla in immunology indications, could launch in the second quarter. All of these drugs could help Celgene diversify its product risks. Also, while further off, we are excited about the rest of Celgene's pipeline, as it could build upon the success of myelodysplastic syndromes drug Vidaza (through an oral and potential more effective version) and also introduce new mechanisms of action to the oncology and immunology markets. In terms of capital allocation, Celgene looks likely to boost returns to shareholders beyond internal profit growth primarily through its share-repurchase program, which has about $2.1 billion remaining on its authorization. With significant cash resources at its disposal ($5.7 billion in cash and investments compared with $4.7 billion in debt at the end of December), some investors may worry that Celgene is gearing up for a large (potentially debt-funded) acquisition to diversify its product portfolio. When pressed about this issue, management has indicated that was not the case, and investors should not expect anything out of the ordinary from Celgene on that front in the near term. Given that relatively conservative stance and the potential for product diversification with its internal products and pipeline candidates, we continue to see significant spread tightening potential in Celgene's bonds.

Juniper Networks(JNPR) (rating: A, narrow moat)
Maturity: 2024
Coupon: 4.50%
Price: $100.90
Yield: 4.39%
Spread to Treasuries: 171
We expect Juniper will remain an important supplier of carrier-grade routers for the foreseeable future. The firm's routers are technically complex and mission-critical, and carriers may spend months evaluating new equipment before making a purchase commitment. As a result, barriers to entry are high, and only Juniper and Cisco Systems (CSCO) (rating: AA, narrow moat) have demonstrated consistent profitability and relatively stable market share over the past decade. While Juniper faces increasing competition from Alcatel-Lucent (ALU) and Huawei, we think its entrenched position in the core of service providers' networks will allow it to maintain a strong market position.

Juniper's gross debt load of $1.35 billion equals 1.7 times trailing EBITDA. The firm ended 2013 with $4.1 billion in cash and investments after generating $609 million of free cash flow during the year. Management intends to return $3 billion to shareholders over the next three years, including $1.2 billion through an accelerated share-repurchase program. To put the current shareholder return plans in perspective, Juniper has returned $1.8 billion to shareholder over the past three years, with net cash on hand growing nearly $300 million during this period. Juniper has generated positive free cash flow every year since 2002 despite the cyclicality of the business and margin pressure seen in recent years.

SCANA (SCG) (rating: BBB+, narrow moat)
Maturity: 2022
Coupon: 4.13%
Price: $100.75
Yield: 4.01%
Spread to Treasuries: 167
Benefiting from leading regulated shareholder returns (mid-10%), SCANA operates in a highly supportive Southeastern regulatory environment. SCANA will further profit from a vast pipeline of infrastructure investments that will earn its leading utility returns on equity. SCANA's 2022s trade 77 and 84 basis points wide of similar-duration paper issued by comparably rated regulated utility peers Duke Energy (DUK) (rating: BBB+, narrow moat) and Xcel Energy (XEL) (rating: BBB+, narrow moat), respectively. We believe SCANA's 2022 bonds represent a compelling positive carry opportunity that is positioned for upside upon the successful completion of two new units at its V.C. Summer nuclear power plant (South Carolina), expected in 2017-18. In the worst-case scenario, assuming SCANA's nuclear plant is stalled or permanently derailed, we believe South Carolina laws will allow SCANA to recover its capital investment as well as any stranded costs through rate-base increases. In March 2013, SCANA successfully attained its combined license from the Nuclear Regulatory Commission. Clearing this last significant regulatory hurdle, SCANA secured the right to construct and operate its planned V.C. Summer nuclear plants.

Vale (VALE) (rating: BBB+, narrow moat)
Maturity: 2022
Coupon: 4.38%
Price: $98.00
Yield: 4.68%
Spread to Treasuries: 231
As one of the lowest-cost producers of iron ore in the world, narrow-moat Vale should benefit from increased production capacity, which we believe will drive out higher-cost producers and generate strong cash flow to support its capital spending and debt reduction. Despite our forecast for declining iron ore prices (from $130/ton today to $90/ton by 2015), we believe Vale's balance sheet is well positioned to absorb lower prices and any further weakness in global steel production. The company's leverage position is among the lowest in our coverage universe, with 2013 year-end debt/last-12-months EBITDA reported at 1.3 times and net debt leverage of 1.1 times. Although Vale is in the midst of a large capital spending program that will increase its iron ore capacity from 300 million tons in 2013 to 450 million tons by 2018, we expect the expansion to further lower the average cost of production while increasing price realizations due to the mining of higher-quality ore. Furthermore, we believe management's renewed focus on expanding its moat-worthy iron ore assets and the recent resolution of its local tax issues provide Vale greater certainty in a generally uncertain industry.

Regions Financial (RF) (rating: BBB, no moat)
Regions Financial RF Issuer Rating: BBB
Maturity: 2018
Coupon: 7.50%
Price: $118.76
Yield: 2.70%
Spread to Treasuries: 147
We believe all U.S. regional banks will continue their balance sheet improvements throughout the year. However, weaker credit names, such as Regions, do not release capital to equity shareholders, or are not allowed by regulators, to the extent that the stronger-rated banks release capital. Investors should look to regional banks like Regions that are currently considered weaker credits but have significant positive momentum in their credit improvement trends. Regions Financial issued benchmark 5-year senior notes at the holding company in April 2013. We view these notes as attractive, but still prefer Regions' 7.50% bank-subordinated notes due in 2018. The bank-subordinated notes have a yield 33 basis points higher than the holding company notes, and we believe the subordinated notes would be structurally senior to holding company debt in a Title II liquidation.

Dave Sekera, CFA has a position in the following securities mentioned above: JPM PBR