Tuesday, June 22, 2010

Junk Bonds Revive on Bernanke ’Subpar’ Economy

Junk Bonds Revive on Bernanke ’Subpar’ Economy: Credit Markets

By Pierre Paulden and Tim Catts

June 23 (Bloomberg) -- Investors are returning to junk bonds after the worst month since 2008 on speculation the economy is growing fast enough to avert corporate defaults without sparking inflation.

“High yield is the place to be,” said Manny Labrinos, a money manager at Nuveen Investment Management who helps oversee $78.4 billion of fixed-income assets. “Subpar growth is somewhat of a Goldilocks scenario because it means rates stay low and people are still going to reach for yield.”

High-risk debt has returned 1.76 percent in June, almost double the gain of investment-grade corporate bonds, Bank of America Merrill Lynch index data show. Underscoring demand, CNH Global NV, the Fiat SpA unit that makes tractors and harvesters, boosted the size of its speculative-grade offering by 50 percent to $1.5 billion in the largest junk-bond sale since April 20.

The rally is eroding a 3.52 percent loss in May as credit- ratings companies upgrade borrowers at the fastest pace since at least 2000 amid rising corporate profits. Economists expect Federal Reserve policy makers led by Chairman Ben S. Bernanke to keep interest rates at record lows as U.S. unemployment holds near a 26-year high.

Moody’s Investors Service upgraded 86 high-yield companies and downgraded 48 in the quarter, a ratio of 1.79 times, Bloomberg data show.

Great Recession ‘Survivors’

“Default rates will be well below most people’s estimates at the beginning of the year,” said Mark Durbiano, head of high yield at Federated Investors Inc., where he oversees $4 billion of speculative-grade debt. “The market is pretty much made up of what I call survivors of the Great Recession, where you defaulted out a lot of the weaker issuers and new issuers are creditworthy.”

Elsewhere in credit markets, the extra yield investors demand to own company bonds instead of government debt was unchanged at 194 basis points, or 1.94 percentage point, the Bank of America Merrill Lynch Global Broad Market Corporate Index shows. Yields averaged 4.027 percent.

Yields on Fannie Mae and Freddie Mac mortgage securities that guide U.S. home-loan rates fell to the lowest in more than a year. On Fannie Mae’s current-coupon 30-year fixed-rate mortgage bonds, or those trading closest to face value, it dropped to about 3.87 percent, within 66 basis points of 10-year Treasuries. That’s the least since April 16. Spreads widened to about 70 basis points in late trading as of 5 p.m. in New York, according to data compiled by Bloomberg.

‘Prepayment Risk’

“In a world where investors can take on various risks such as sovereign risk, credit risk, liquidity risk and prepayment risk, prepayment risk seems the least distasteful at the moment,” JPMorgan Chase & Co. analysts led by Matthew Jozoff in New York wrote in a June 18 report.

Investors in agency mortgage bonds may be paid back faster than they expect if home-owners refinance or move, and slower if financing costs rise. That adds risk as they may need to make new investments at a time when yields are unfavorable. Spreads on the securities are dropping toward record lows set when the Fed was buying the debt.

Vodafone Group Plc, the world’s largest mobile-phone company, is talking with lenders to raise at least $4 billion to refinance debt. The company, based in Newbury, England, plans to get a five-year credit line to replace a three-year deal signed in 2008, said three people familiar with the situation who declined to be identified because the talks are private.

Vodafone spokesman Simon Gordon declined to comment.

Credit Risk

The cost of protecting Asian corporate and sovereign bonds from default increased as an unexpected drop in U.S. home sales raised concern over the strength of growth in the world’s largest economy.

The Markit iTraxx Asia index of 50 investment-grade borrowers outside Japan rose 8 basis points to 131 basis points as of 9:33 a.m. in Singapore, Royal Bank of Scotland Group Plc prices show.

U.S. stocks sank the most in almost three weeks after the National Association of Realtors said sales of previously owned homes dropped 2.2 percent in May.

The Markit CDX North America Investment Grade Index of credit-default swaps, which investors use to hedge against losses on corporate debt or speculate on creditworthiness, climbed 7.3 basis points to a mid-price of 115 basis points as of 6:23 p.m. in New York, the first increase since June 9, according to Markit Group Ltd. In London, the Markit iTraxx Europe Index of swaps on 125 companies with investment-grade ratings increased 5.5 to 118.1, Markit prices show.

The indexes typically rise as investor confidence deteriorates and fall as it improves. The swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Hurricane Season

The cost to protect BP Plc’s bonds against default climbed as the first storm of the Atlantic hurricane season threatens to disrupt efforts to clean up the worst oil spill in U.S. history.

Credit-default swaps tied to London-based BP surged 61 basis points to 538.9 basis points, according to CMA DataVision prices. The storm may enter the Gulf of Mexico as soon as next week, a Planalytics Inc. meteorologist said. Forecasters including AccuWeather Inc. are predicting the season may be among the worst on record.

In emerging markets, the extra yield investors demand to own company bonds relative to government debt rose 11 basis points to 315 basis points, the biggest increase since June 4, according to JPMorgan’s Emerging Market Bond index.

Argentine bonds declined, snapping a nine-day streak of gains, as the government’s offer to restructure $18.3 billion in defaulted debt expired. The yield on the country’s 7 percent bonds due in 2015 rose 57 basis points to 13 percent as of 5:30 p.m. in New York. The price slid 1.82 cents to 79.17 cents on the dollar.

High-Yield Sales

Issuance of speculative-grade debt, ranked below Baa3 by Moody’s and lower than BBB- at Standard & Poor’s, is reviving after Spain sold bonds last week and equity analysts boosted second-quarter estimates for companies in the S&P 500 Index to $19.72 per share from $19.11, according to JPMorgan.

CNH Global’s 7.875 percent notes maturing in December 2017 priced to yield 536 basis points more than similar-maturity Treasuries, Bloomberg data show. The offering from the Amsterdam-based unit of Italian automaker Fiat that makes Case and New Holland agricultural equipment adds to $4.3 billion of high-yield bonds sold this month, Bloomberg data show.

The sale was the biggest U.S. high-yield issue since CF Industries Holdings Inc., the Deerfield, Illinois-based fertilizer maker acquiring Terra Industries Inc., sold $1.6 billion of 8- and 10-year notes on April 20, according to Bloomberg data.

Funding Costs

Junk bond sales declined 80 percent last month to $6.76 billion from $33.4 billion in April as European banks’ funding costs soared and investors sought the safety of U.S. government debt.

Investors put $164 million into high-yield bond funds in the week ended June 16 after withdrawing $6.27 billion in the five previous periods, according to EPFR Global, a Cambridge, Massachusetts-based research firm that tracks asset allocations.

Last month’s decline in junk bond returns was the worst since an 8.4 percent drop in November 2008, according to Bank of America Merrill Lynch’s U.S. High Yield Master II index. Investment-grade bonds have returned 0.98 percent in June, following a loss of 0.57 percent last month.

“Sentiment has definitely improved from a very low base at the beginning of the month,” said James Lee, a fixed-income analyst at Calvert Asset Management in Bethesda, Maryland, which has $7.6 billion of fixed-income assets under management. “The high-yield market is recovering and investors have money to put to work and they are looking for new deals to do it.”

Fed Meeting

All 97 economists surveyed by Bloomberg forecast Fed policy makers will keep their target rate for overnight loans between banks at a record low range of zero to 0.25 percent following a two-day meeting that ends today. The hazard posed by the European debt crisis, joblessness and a lack of inflation add to the reasons why central bankers will focus on sustaining the economic rebound.

Governments across the 16-nation euro region are cutting spending after Greece’s near default sparked investor concern that budget deficits are spiraling out of control. While tighter fiscal policy may slow economic growth, the crisis has also pushed the euro down 13 percent against the dollar this year, boosting some European exports.

The difference in yield between five-year Treasuries and Treasury Inflation Protected Securities indicates investors anticipate an inflation rate of 1.69 percent in the next five years, compared with 2.01 percent on April 28, when policy makers concluded their last meeting on monetary policy.

Corporate Spreads

Corporate spreads should decrease based on the rate that companies are defaulting on debt, said Martin Fridson, a global credit strategist at BNP Paribas Asset Management in New York.

The trailing three-month default rate of 2.95 percent on May 31 signals that the spread on high-yield debt should be 485 basis points, Fridson said, citing BNP and Merrill Lynch index data going back to 1996. Relative yields over government debt have declined 23 basis points this month to 675 basis points, Bank of America Merrill Lynch index data show.

“I think we can say with confidence that the spread is too wide relative to the prevailing default rate,” Fridson said. “I attribute that fact to the anxiety about sovereign risk. More is coming out suggesting that the banks will be covered and those concerns are somewhat overstated.”

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