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Bernanke's Nonexistent Junk Bond Revival: Street Whispers

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Conventional wisdom would have it that the loose policy of the Federal Reserve is pushing investors into risky assets such as junk bonds, driving down yields and giving cash-strapped corporations incentive to take advantage of low rates to lever up their balance sheets.

On the surface, the data supports such logic.

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Junk bond issuance is on pace to shatter records in 2012, according to data from Dealogic, as highly-levered companies tap investors for some of the cheapest debt financings in history. The trend isn't expected to end anytime soon.

Fed chairman Ben Bernanke has signaled to markets the central bank won't raise short-term interest rates until mid-2015. The Fed's mortgage bond buying program -- otherwise known as QE3 -- is also forecast to remain in place long after inflation rises above current levels.

But Wall Street investment banks and investors should be wary of misreading those surface trends heading into 2013. A closer look at the data signals corporations are far from gorging on record cheap debt and Ben Bernanke's oft-cited easy money may be more a of mirage in explaining low yields and booming junk bond markets.

In fact, for Wall Street players like Goldman Sachs (NYSE:GS), Morgan Stanley (NYSE:MS), JPMorgan (NYSE:JPM), Bank of America (NYSE:BAC), and Citigroup (NYSE:C), a different read on present-day issuance records may signal a looming market bust.

Junk bond issuance is hitting new records because corporations are refinancing debts to simultaneously extend maturities and take advantage of today's low rates.

Records aren't being set because new companies are entering the market to add to their debt pile -- and there's a big difference between companies refinancing and those that are levering-up, even if the distinction isn't borne out in data, which shows over $322 billion in junk issuance as of November 28, a 12.6% increase from the previous record annual pace set in 2010.

Consider the biggest junk issuers in November, such as Clear Channel (PINK:CCMO), Sprint Nextel (NYSE:S), E*Trade Financial (NASDAQ:ETFC), Terex (NYSE:TEX), and Clean Harbors (NYSE:CLH). Four of those tapped junk markets in billion-dollar sized issues simply to finance into new debts yielding between 4% and 7%, while extinguishing bonds carrying higher rates. Only Clean Harbors was in the market to add to its debt load, in a financing for a $1.25 billion late October acquisition of recycling specialist Safety Kleen.

November wasn't an aberration. The same dynamics have been present in junk bond markets since the market bottom in 2009... and that should scare some people.

As issuance data shows a record year for junk bonds markets, a screen of balance sheets across the S&P 500 Index (INDEXSP:.INX) and Russell 2000 Index (NYSEARCA:IWM) shows companies are keeping debt levels relatively unchanged this year and a trend of deleveraging since the financial crisis.

Data compiled by Bloomberg shows per share debt levels across the S&P 500 are up just $26 this year, and $36 in the Russell 2000, an increase of 3.5% and 8%, respectively. By measure of net debt-to-earnings, before interest, taxes, depreciation, and amortization (EBITDA) - per share leverage has fallen in both indices, the Bloomberg data show, even as overall issuance is up nearly 30%, according to Dealogic.

If junk bond market records are mostly a result of refinancing efforts, then simply looking at 2012 issuance numbers overstates the actual supply of debt available for bond investors to buy. It also gives way to an alternate explanation for record low rates, while giving Ben Bernanke some credit for Wizard of Oz-like monetary policy.

Yes, a hunt for yield and investor fear is creating record inflows into junk bond ETFs. But, record low rates may be as much a result of a shortage in junk bond market supply to meet that demand.

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So what does it all mean? For one, Wall Street should be worried.

Bond underwriting accounts for roughly 10% of revenue at investment banks like Goldman Sachs, and it helps to fuel for far more lucrative trading desks.

If refinancing soon runs its course after years of record-setting pace, investment banks may soon lose a key revenue stream in an already murky earnings environment. Bond issuance data may also overstate the animal spirits of corporations, providing mixed signals on a long-awaited M&A boom.

Broader stories also emerge.

C-Suites across America may not be getting the credit they deserve for repairing balance sheets in the wake of the crisis. Overall debt and debt-to-EBITDA levels across the S&P are roughly 40% below pre-bust levels, paving the way for flexibility to increase dividends or map out new growth strategies in coming years.

For instance, investment grade companies like Disney (NYSE:DIS) and Costco (NASDAQ:COST) have recently returned to bond markets to finance large dividend increases. Meanwhile, Amazon (NASDAQ:AMZN) recently tapped bond markets for the first time in a decade, as the company ratchets up its competition against retailers Wal-Mart (NYSE:WMT) and tech giants Apple (NASDAQ:AAPL) and Microsoft (NASDAQ:MSFT).

Most important; however, is that bond yields may not be as predictable as simply following the Fed. If falling yields are, in part, a function of weak supply, then rising yields may have as much do with C-Suite aggression and general re-leveraging throughout corporate America as any change in Fed policy.

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