AT&T Bonds: Not A Ringing Endorsement

Aug. 27, 2013 4:24 PM ETAT&T Inc. (T)VZ2 Comments

The telecommunications sector around the world is experiencing enormous disruption. This note uses the default probabilities and bond credit spreads of AT&T Inc. (NYSE:T) to measure the reward-to-risk ratio on the company's bonds. Today's study incorporates AT&T bond price data as of August 26, 2013. A total of 355 trades were reported on 25 fixed-rate non-call bond issues of AT&T with trade volume of $109.6 million. After eliminating one bond issue with flawed data, we analyze the remaining 349 trades for $109.5 million in principal amount in this note.

Institutional investors around the world are required to prove to their audit committees, senior management and regulators that their investments are in fact "investment grade." For many investors, "investment grade" is an internal definition. For many banks and insurance companies "investment grade" is also defined by regulators. We consider whether or not a reasonable U.S. bank investor would judge the firm to be "investment grade" under the June 13, 2012, rules mandated by the Dodd-Frank Act of 2010, which requires that credit rating references be eliminated. The new rules delete references to legacy credit ratings and replace them with default probabilities as explained here.

Assuming the recovery rate in the event of default would be the same on all bond issues, a sophisticated investor who has moved beyond legacy ratings seeks to maximize revenue per basis point of default risk from each incremental investment, subject to risk limits on macro-factor exposure on a fully default-adjusted basis. In this note, we also analyze the maturities where the credit spread/default probability ratio is highest for AT&T Inc.

Term Structure of Default Probabilities

Maximizing the ratio of credit spread to matched maturity default probabilities requires that default probabilities be available at a wide range of maturities. The graph below shows the current default probabilities for

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Donald R. van Deventer is a Managing Director in the Center for Applied Quantitative Finance at SAS Institute, Inc. Prior to the acquisition of Kamakura Corporation by SAS on June 24, 2022, Dr. van Deventer was the Chairman and Chief Executive Officer of Kamakura Corporation. He founded the Kamakura Corporation in April, 1990. The second edition of his book, Advanced Financial Risk Management (with Kenji Imai and Mark Mesler) was published in 2013.  Dr. van Deventer was senior vice president in the investment banking department of Lehman Brothers (then Shearson Lehman Hutton) from 1987 to 1990. During that time, he was responsible for 27 major client relationships including Sony, Canon, Fujitsu, NTT, Tokyo Electric Power Co., and most of Japan's leading banks. From 1982 to 1987, Dr. van Deventer was the treasurer for First Interstate Bancorp in Los Angeles. In this capacity he was responsible for all bond financing requirements, the company’s commercial paper program, and a multi-billion dollar derivatives hedging program for the company. Dr. van Deventer was a Vice President in the risk management department of Security Pacific National Bank from 1977 to 1982. Dr. van Deventer holds a Ph.D. in Business Economics, a joint degree of the Harvard University Department of Economics and the Harvard Graduate School of Business Administration. He was appointed to the Harvard University Graduate School Alumni Association Council in 1999 and served through 2021. Dr. van Deventer was Chairman of the Council for four years from 2012 to 2016. From 2005 through 2009, he served as one of two appointed directors of the Harvard Alumni Association representing the Graduate School of Arts and Sciences. Dr. van Deventer also holds a degree in mathematics and economics from Occidental College, where he graduated second in his class, summa cum laude, and Phi Beta Kappa. Dr. van Deventer speaks Japanese and English.

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