Corporate Bond Spreads Rise Most Since November: Credit Markets

By Sapna Maheshwari and John Detrixhe

 

Feb. 8 (Bloomberg) -- Corporate borrowing costs are rising at the fastest pace in more than two months on concern that worsening government finances will slow the global economy and make it harder for companies to meet debt payments.

The extra yield investors demand to own corporate bonds instead of government securities widened 4 basis points last week to 169 basis points, the most since the period ended Nov. 27, according to the Bank of America Merrill Lynch Global Broad Market Corporate Index. Spreads widened for three weeks, the longest stretch in about a year, while those for U.S. high- yield, high-risk companies expanded by the most since August.

Optimism over the recovering economy that made January the best start to a year since 2001 for the corporate bond market is fading as finances in Greece, Spain and Portugal deteriorate, Japan struggles to emerge from recession and concerns grow that emerging-market valuations are too high. BES Investimento do Brasil pulled an international bond offering of as much as $350 million, capping a week of canceled sales from India to Korea.

“The potential impact of spill-over into other markets has gotten folks to look at risk assets of all types, and you’re seeing a pullback across the globe,” said Andrew Karp, a managing director on Bank of America Corp.’s investment-grade syndicate desk in New York.

Slowing Returns

Returns are slowing, with company debt gaining 0.12 percent this month, after adding 1.83 percent in January including accrued interest, the Merrill Lynch index shows. Treasuries have returned 0.41 percent this month, after handing investors 1.58 percent last month, another Merrill Lynch index shows. U.S. corporate bond sales are down 11 percent this year to $147.4 billion, from $165.6 billion in the same period of 2009, according to data compiled by Bloomberg.

Declining issuance and widening spreads may continue as borrowers monitor how government deficits are managed in Europe, Karp said.

Elsewhere in credit markets, emerging-market bond spreads are the widest since November, the cost to insure corporate debt against default is near the highest in two months, and prices of securities backed by U.S. government agencies Fannie Mae and Freddie Mac with relatively high coupons are at record highs.

At their meeting in Iqaluit, Canada, the Group of Seven finance ministers pledged to press ahead with economic stimulus measures even as investors intensify their focus on mounting budget deficits. Canadian Finance Minister Jim Flaherty told reporters that “we need to continue to deliver the stimulus to which we are mutually committed and begin looking at exit strategies to move to a more sustainable fiscal track.”

‘Running a Gauntlet’

“They are running a gauntlet, hemmed in between debt crisis on the one side and a double-dip recession on the other,” said T.J. Marta, chief market strategist at Marta On The Markets LLC, a financial-research firm in Scotch Plains, New Jersey. Marta is also a former fixed-income and currency strategist at RBC Capital Markets and Citigroup Inc.

Sovereign debt concerns are overshadowing positive economic news, Deutsche Bank AG fixed-income strategists Mustafa Chowdhury in New York and Ralf Preusser and Francis Yared in London wrote in a note to investors.

The U.S. unemployment rate fell to 9.7 percent in January, the lowest level since August, from 10 percent the prior month, even as payrolls declined by 20,000, the Labor Department said Feb. 5. White House economic adviser Lawrence Summers said the nation is not “too far” from the start of a rebound in jobs.

Credit-Default Swaps

Credit-default swaps on the Markit iTraxx Crossover Index, linked to 50 mostly high-yield European companies and used to speculate on creditworthiness or to hedge against losses, fell to 485 basis points, according to JPMorgan Chase & Co. prices at 9:56 a.m. in London. It was at 494 basis points on Feb. 5, the highest level since December.

The Markit CDX North America Investment-Grade Index of default swaps on 125 companies traded at the highest level in more than two months, increasing 9.5 basis points over two days to 101.75 basis points on Feb. 5, prices from broker Phoenix Partners Group showed.

The cost of five-year default insurance on Greece’s government bonds fell from a record, with credit-swaps linked to the nation declining 9.5 basis points to 398, according to CMA DataVision. Contracts on Portugal’s debt rose 6.5 basis points to an all-time high of 233.5, CMA prices show, signalling a deterioration in investor perceptions of credit quality.

Credit-default swaps pay the buyer face value if a borrower fails to adhere to its debt agreements in exchange for the underlying securities or the cash equivalent. A basis point is 0.01 percentage point, and equals $1,000 a year on a contract protecting $10 million of debt.

‘Who is Exposed?’

“The concern is, if you have a sovereign default, who is exposed?” said Joe Jackson, head of credit research at St. Petersburg, Florida-based Eagle Asset Management, which invests about $18 billion. “It looks like people are aggressively trying to buy protection against Greece, which leads you to think there’s probably a lot of exposure out there.”

Speculative-grade corporate bond spreads widened 35 basis points last week, the fourth straight increase and the biggest jump since the week ended Aug. 14 when they expanded 37 basis points, according to the Bank of America Merrill Lynch U.S. High-Yield Master II index. The bonds have lost 0.62 percent this month, after rallying 1.52 percent in January.

U.S. investment-grade credit spreads widened 5 basis points, the biggest weekly increase in yields relative to Treasuries since the period ended Oct. 2, when they rose 8 basis points, according to Merrill’s U.S. Corporate Master index.

Emerging-Market Bonds

Emerging-market bonds have been among the hardest hit, with the difference between yields on the bonds and government debt reaching 3.2 percentage points on average at the end of last week, up from the low this year of 2.95 percentage points on Jan. 8, according to JPMorgan’s EMBI+ index.

BES Investimento do Brasil postponed its offering because it would have been more expensive given “market volatility,” Paulo Augusto Saba, managing director for global markets, sales and fixed-income trading in Brazil, said in a telephone interview. BES was planning to issue five-year bonds, he said. BES is a unit of Lisbon-based Banco Espirito Santo SA.

“If we were to do the issuance now, we would have to pay much more, and we didn’t need to do so,” Saba said from Sao Paulo. “I want to do a beautiful deal. I don’t want to do a Frankenstein deal in the market.”

India’s Bank of Baroda canceled a bond sale denominated in U.S. dollars, and Korea Hydro & Nuclear Power Co., a unit of state-run Korea Electric Power Corp., delayed a foreign-currency debt offering until after March, said people familiar with the matter who declined to be identified because the decisions hadn’t been publicly announced.

Kraft Bonds Rally

Bonds issued last week by Kraft Foods Inc., the maker of Oreos and Cheez Whiz, rose in secondary trading. Northfield, Illinois-based Kraft sold $9.5 billion of debt in a four-part issue after increasing the size of the sale from $4 billion and boosting the spreads offered to investors.

The food maker’s 5.375 percent notes due in 2020 gained 1.3 cents on the dollar from 99.176 cents to yield a spread of 176.7 basis points, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The debt sold at a spread of 190 basis points, Bloomberg data show.

“It has performed really well,” said Jackson of Eagle Asset Management. “You start to get concerned if you see these deals go really poorly. So far we haven’t seen that.”

Not Panicking

New bonds from Sacramento, California-based McClatchy Co. also rose, in a sign investors weren’t panicking, money-manager Martin Fridson wrote in an e-mail. The newspaper publisher’s $875 million of 11.5 percent notes sold at a spread of 866 basis points, and rose to 99 cents on the dollar on Feb. 5 from an issue price of 98.824 cents.

“The newspaper business isn’t one of the strongest sectors of the economy,” wrote Fridson, chief executive officer of New York-based Fridson Investment Advisors. “One would not have expected the offering to fare as well as it did if institutional investors were in a frantic selling mode.”

Mortgage bonds with higher coupons and guaranteed by Washington-based Fannie Mae and Freddie Mac in McLean, Virginia climbed to records as benchmark Treasury notes gained and monthly reports showed prepayments slowing last month.

Fannie Mae’s 30-year fixed-rate securities with 6 percent coupons have climbed 1.2 percent since Dec. 28, to a new high of 107.2 cents on the dollar, Bloomberg data show. Similar bonds with 4.5 percent coupons, whose returns vary less with changes in prepayments because they trade closer to face value, have fallen 1.2 percent after reaching their second-highest level ever on Nov. 30, to 101.4 cents.

The data released by Fannie Mae and Freddie Mac suggested that the government-supported mortgage companies continued to buy loans out of the bonds they guarantee after the loans are modified, as required by the debt’s contracts, according to JPMorgan and Barclays Capital analyst reports.

To contact the reporters on this story: Sapna Maheshwari in New York at smaheshwar11@bloomberg.net; To contact the reporters on this story: John Detrixhe in New York at jdetrixhe1@bloomberg.net

Last Updated: February 8, 2010 05:05 EST