Wednesday, August 4, 2010

Junk Debt ‘Bubblelicious,’ Prices Approach Par: Credit Markets

By John Detrixhe

Aug. 4 (Bloomberg) -- Junk bonds are closing in on par for the second time this year as fixed-income investors bet recent signs of economic weakness won’t be enough to derail corporate profits and the ability of the neediest borrowers to repay debt.

High-yield bonds rose to 98.99 cents on the dollar yesterday after falling as low as 94.47 cents on May 25, according to Bank of America Merrill Lynch index data. In the prior rally, the debt climbed to 99.67 cents on April 30. Prices last rose to par in June 2007, just before credit markets began to seize up as losses on subprime mortgages spread.

Investors are pouring money into bond funds at the fastest pace in 15 months as defaults slow. Frontier Communications Corp. and Freescale Semiconductor Inc. led a 3.47 percent return for high-yield bonds in July, the most since September, even as weakening consumer spending and factory orders signal the recovery is losing momentum.

“It’s a little bit bubblelicious,” said Don Ross, who helps oversee $9.5 billion of assets as global strategist for Titanium Asset Management Corp. Except for bond-coupon payments, “you don’t have a lot of upside from here,” he said.

High-yield funds had $2.8 billion of inflows in July, the most since April 2009, and have received $3.6 billion in cash this year, Bank of America Merrill Lynch analysts wrote Aug. 2 in a report. Junk bonds yield 8.492 percent, according to the bank’s U.S. High Yield Master II index.

‘Pretty Interesting’

Investors are putting cash into junk-bond mutual funds as money market funds from companies such as Federated Investors Inc. and JPMorgan Chase & Co. offer yields at or below 0.25 percent, according to data compiled by Bloomberg.

“The average retail customer can’t live on 1 percent and that’s the issue,” said Jon Budish, senior vice president of high yield at Jefferies & Co. in Short Hills, New Jersey. “Until the default rate changes or you get a lot of downgrades, or until the Fed says something different, high-yield seems pretty interesting.”

Elsewhere in credit markets, the extra yield investors demand to own company bonds instead of government debt was unchanged at 176 basis points, or 1.76 percentage point, Bank of America Merrill Lynch’s Global Broad Market Corporate index shows. Yields averaged 3.705 percent.

The cost of protecting corporate debt in the U.S. from default rose from an almost 12-week low.

Credit-Default Swaps

The cost of insuring against losses on European corporate bonds rose from a three-month low, according to traders of credit-default swaps. Contracts on the Markit iTraxx Crossover Index of 50 mostly junk-rated companies climbed 7.7 basis points to 462.9 as of 10:12 a.m. in London, according to Markit Group Ltd.

Credit swaps on financial-company debt also advanced, with the Markit iTraxx Financial Index of 25 of the region’s banks and insurers adding 2.5 basis points to 109.5, rising from the lowest since April 21, JPMorgan Chase & Co. prices show.

Default swaps on BP Plc fell to a two-month low as the company sought to assure its survival by planning to sell assets from Alaska to Venezuela, and as it got closer to permanently sealing the Gulf of Mexico oil spill.

Contracts tied to the U.K. oil company’s debt dropped 24.5 basis points to 281.5, according to data provider CMA, even as its stock declined 1.1 percent to 411.2 pence on speculation the divestments would hurt earnings.

Asset Sales

BP Chairman Carl-Henric Svanberg said last week that the company will triple its planned asset sales to as much as $30 billion to meet the cost of the world’s worst accidental oil spill. BP said today it reached a “significant milestone” in its attempt to plug the leak, using drilling mud to control the pressure in the well.

Credit-default swaps typically rise as investor confidence deteriorates and fall as it improves. The contracts 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 swap protecting $10 million of bonds and loans.

In emerging markets, the extra yield investors demand to own corporate bonds rather than government debt was unchanged at 270 basis points after tightening 44 basis points from July 16, according to JPMorgan index data.

Oaktree, Almatis

Oaktree Capital Management LLC agreed to support Dubai International Capital LLC’s plans to restructure the debt of German alumina-products maker Almatis.

Oaktree, the largest lender to Almatis with 46 percent of the company’s senior debt, had vied for control of Almatis since its $40 million default last year. Los Angeles-based Oaktree will drop efforts to take over Almatis after its competing debt proposal was rejected, two people familiar with the matter said yesterday.

Almatis said today that the U.S. bankruptcy court had granted it permission to prepay senior lenders in full and enhance recoveries for junior lenders, according to a statement. Under the plan, Dubai International, the emirate’s investment fund, will inject $100 million of equity into Almatis.

MetLife Inc. sold $3 billion of bonds to help pay for its acquisition of an American International Group Inc. unit, leading U.S. sales of $9.2 billion for the day.

The offering from MetLife, the largest U.S. life insurer, was split into four parts, Bloomberg data show. The company sold $250 million of 3-year floating-rate debt, $1 billion each of 3 1/2- and 10 1/2-year notes, and $750 million of 30 1/2-year bonds. Proceeds will be used to help finance the acquisition of AIG’s American Life Insurance Co., New York-based MetLife said yesterday in regulatory filings.


Bonds from New York-based Citigroup Inc., the bank 18 percent owned by the U.S. government, were the most actively traded U.S. corporate securities by dealers, with 202 trades of $1 million or more, Bloomberg data show. ArcelorMittal, the world’s biggest steelmaker, ranked second with 180. Arch Coal Inc. of St. Louis, with 59 trades, was the most active in junk bonds, which are rated below Baa3 by Moody’s Investors Service and lower than BBB- by Standard & Poor’s.

When high-yield bonds last approached par more than three months ago, the Fed said that “economic activity has continued to strengthen,” according to an April 28 statement. The labor market was “beginning to improve” and officials said growth in household spending has “picked up recently.”

Commerce Department figures released yesterday in Washington showed consumer spending, pending home sales and factory orders were all weaker than projected in June. Household purchases, which account for about 70 percent of the economy, were unchanged from May.

Fed’s Overnight Rate

The Fed has kept its target overnight lending rate at zero to 0.25 percent since December 2008. Futures traders have placed 6.3 percent odds, versus 14.9 percent a month ago, of an increase of at least a quarter percentage point, according to Bloomberg data.

While economic data casts doubt on the recovery, 75.8 percent of companies in the S&P 500 that have reported second- quarter earnings have beaten analysts’ estimates, Bloomberg data show.

“The key question is how you interpret the data, and every day you see widely divergent interpretations,” said Martin Fridson, global credit strategist at BNP Paribas Asset Management in New York. “I don’t see signs of frothiness” in high-yield bonds, said Fridson, who began his career as a corporate debt trader in 1976.

Relative Yields Narrow

Relative yields on speculative-grade bonds have narrowed to 655 basis points from 727 basis points on June 11, Bank of America Merrill Lynch index data show. That spread will tighten to 600 basis points by the end of 2010 and to 500 basis points a year from now, the Bank of America Merrill Lynch analysts wrote.

The average price on euro-denominated junk bonds has jumped 5.9 cents since June 10 to 93.03 cents on the euro, the highest in almost three months, according to Bank of America Merrill Lynch’s Euro High Yield Constrained Index. Prices fell to a 2010 low of 87.1 cents on the euro in June as investors fled riskier assets on mounting concern of a sovereign default in the region.

S&P upgraded 245 junk bonds in the U.S. this year and downgraded 185, Bloomberg data show. Last year it upgraded 121 and lowered 676 during the same period.

The global default rate tumbled to 6.1 percent in June from about 12.1 percent a year earlier, and will slide to 2.4 percent by year-end, according to Moody’s. S&P said Aug. 2 the global default rate was 5.04 percent, down from a high of 9.9 percent in November 2009.

‘Strongest Game’

“Corporate metrics are still about the strongest game in town,” said Ross, who is based in Cleveland. “The fundamentals are significantly better than the last time we were approaching anything near this effervescence.”

Sales of high-yield debt more than doubled in July to $16.67 billion from $7.84 billion in June, Bloomberg data show.

Bank of America Merrill Lynch’s high-yield index has gained 8.7 percent this year. Debt of Frontier, the Stamford, Connecticut-based phone company serving rural markets, returned 6.97 percent in July. Freescale, the Austin, Texas-based chipmaker rose 6.88 during the period.

“It’s very much a supply and demand market,” Budish said. “Right now the demand outstrips the supply greatly.”

To contact the reporter on this story: John Detrixhe in New York at

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