By Bryan Keogh and Kate Haywood – May 26, 2010
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The percentage of corporate bonds considered in distress surged this week to the highest since 2009 as investors dumped debt of the neediest borrowers on concern that Europe’s fiscal crisis may make it harder for them to refinance.
Some 17 percent of junk bonds yield at least 10 percentage points more than Treasuries, up from 9.2 percent last month, Bank of America Merrill Lynch’s Global High-Yield Index shows. The jump is the biggest since the distress ratio rose 11 percentage points in November 2008, two months after Lehman Brothers Holdings Inc. collapsed. Bonds of MGM Mirage and Freescale Semiconductor Inc. joined the list in May.
U.S. distressed bonds have lost 10 percent this month, according to the indexes, amid speculation Greece and other nations in Europe with rising budget deficits may not be able to meet their debt payments, causing credit markets to seize up again. Junk bond sales plunged this month to the lowest level since March 2009, data compiled by Bloomberg show.
“It’s going to be really difficult for some of these companies to address their debt piles,” said Mark Dewar, a London-based senior managing director at FTI Consulting who advised lenders to Lehman Brothers after the U.S. bank filed for bankruptcy. “It becomes a downward spiral.”
The 5.875 percent notes of Las Vegas casino operator MGM Mirage due in 2014 yield 11 percentage points more than Treasuries, becoming distressed on May 20 for the first time since December, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
The spread on the 9.125 percent notes due in 2014 issued by Austin, Texas-based Freescale Semiconductor, the computer chipmaker bought in 2006 by private-equity firms led by Blackstone Group LP, is 11.7 percentage points. That’s up from 7.95 percentage points on April 26, Trace data show.
Elsewhere in credit markets, an indicator of U.S. corporate credit risk rose, reversing an earlier decline as the euro extended a slump and stocks fell amid reports China may consider reducing European government bond investments. Two-year U.S. interest rate swap spreads widened and Goldman Sachs Group Inc. sold $1.25 billion of 10-year senior notes, according to Bloomberg data.
Credit-default swaps on the Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, rose 3.67 basis points to 126.75 basis points as of 5:11 p.m. in New York, according to Markit Group Ltd. The index, which earlier fell to as low as 118.5 basis points, typically rises as investor confidence deteriorates and declines as it improves.
European Risk Falls
In London, the Markit iTraxx Europe index of 125 companies with investment-grade ratings dropped 4.5 basis points to 123.75, Markit prices show.
Investor confidence was boosted as the Organization for Economic Cooperation and Development raised its global growth forecasts for this year and next and data showed that new home purchases in the U.S. jumped last month to a two-year high.
Credit 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.
The difference between the two-year swap rate and the comparable-maturity Treasury note yield, known as the swap spread, fell as much as 11.18 basis points to 40.58 basis points, the lowest since May 21, before widening to 48.63 at 6:38 p.m. in New York, from 51.76 basis points May 25. The spread has increased from this year’s low of 9.63 on March 24, the narrowest since 1993.
Goldman Sachs Bonds
Goldman Sachs’s 6 percent bonds priced to yield 280 basis points more than similar-maturity Treasuries, according to Bloomberg data.
The New York-based bank sold $2 billion of 5.375 percent, 10-year notes on March 1 at a spread of 190 basis points, according to Bloomberg data. It issued an additional $750 million of the debt on March 19 at a 175 basis-point spread, Bloomberg data show.
Freddie Mac, the government-supported mortgage company, plans to sell notes due in 2012 in a benchmark offering, the firm said in an e-mailed statement. The debt may yield 30 basis points more than similar-maturity Treasuries, according to a person familiar with the offering who declined to be identified because terms aren’t set.
Benchmark sales are typically at least $500 million. A basis point is 0.01 percentage point.
Agency Debt Spreads
Spreads on so-called agency debt other than mortgage securities — including corporate borrowing by Washington-based Fannie Mae and Freddie Mac, bonds from the Federal Home Loan Bank system, and U.S.-guaranteed bank notes — rose to 31 basis points on May 25, according to Barclays Plc index data. That’s up from 24 basis points on March 31, when the Federal Reserve ended $171 billion of purchases of such debt.
In emerging markets, the extra yield investors demand to own debt securities instead of U.S. Treasuries declined 6 basis points to 340, according to JPMorgan Chase & Co.’s Emerging Market Bond index.
Yields on Brazil’s interest-rate futures contracts rose from a one-month low on speculation the European debt crisis has failed to slow growth in Latin America’s biggest economy. The yield on the contract due in January, the most active in Sao Paulo trading, rose 5 basis points to 10.91 percent at 5 p.m. New York time. It reached 10.86 percent yesterday, the lowest level since April 27.
The riskiest debt is losing favor with investors after returning about 70 percent from March 2009 through last month as credit markets and the economy recovered from the worst financial crisis since the 1930s.
Junk bonds globally have lost 4.4 percent in May, on pace for the first monthly decline in 15 months and the biggest drop since November 2008, Bank of America Merrill Lynch indexes show. Investors pulled more than $1 billion from high-yield funds during the third week of May, after redeeming $2.1 billion the previous period, according to EPFR Global, a Cambridge, Massachusetts, research firm that tracks fund flows.
Investors are unloading risky assets on concern European governments won’t be able to coordinate a response to surging levels of debt from Greece to the U.K., threatening the global economic recovery. Spain became the focus of the crisis this week as four of its savings banks said they plan to combine to form the nation’s fifth-largest financial group, while the Washington-based International Monetary Fund said the country’s financial industry “remains under pressure.”
Spreads This Week
“Debt restructuring may be needed for one or two fiscally weak euro members,” Nobel Prize-winning economist Robert Mundell said today at a conference in Warsaw.
The yield spread on junk bonds has widened 7 basis points this week to 727 basis points after surging to 743 basis points on May 25, the highest level since Dec. 9, Bank of America Merrill Lynch index data show. Spreads have widened 173 basis points since reaching a 30-month low of 554 basis points April 26. High-yield debt is rated below Baa3 by Moody’s Investors Service and BBB- by Standard & Poor’s.
“The market will hit massive roadblocks when companies have big principal payments coming due and they don’t have the money to repay them,” said Stefan Benedetti, a partner at Dusseldorf-based restructuring specialist Nikolaus & Co LLP. “If the bond market isn’t open, shareholders will have to hand back the keys to the banks.”
While spreads have surged, they remain below the record 21.9 percentage points reached on Dec. 15, 2008, when almost 90 percent of speculative-grade securities were considered distressed, Bank of America Merrill Lynch index data show.
“We haven’t seen any company reports which suggests they’re on the verge of blowing up,” said Alex Moss, a fund manager at Insight Investment Management in London. “There are concerns that contagion from Europe will lead to a double-dip recession, but company fundamentals aren’t showing this.”
The market turmoil is curtailing companies’ efforts to borrow to help refinance $1.2 trillion of bonds and loans expected to come due through 2014, according to Bloomberg data. Speculative-grade companies have sold $7.55 billion of bonds globally this month, the least since March 2009, compared with $41.6 billion in April.
Saudi Basic Industries Corp., the world’s biggest petrochemicals maker, and Las Vegas-based Allegiant Travel Co. pulled bond deals this week, bringing the total to at least 21 borrowers that have postponed sales since April, Bloomberg data show.
“If financing markets stay closed for the next 12 months or longer, then there’s a problem,” said Andrew Wilmont, a London-based money manager with Axa Investment Managers U.K. Ltd. who helps oversee $5 billion of speculative-grade debt. “But right now, we’re talking about just a month’s worth of extreme volatility.”
Corporate borrowers will struggle to adjust to the “powerful regime change” as a long-term process of companies and countries cutting debt damps global growth, Stephen Moyer and Michael Watchorn, money managers at Newport Beach, California-based Pacific Investment Management Co., which runs the world’s largest bond fund, wrote in a report yesterday.
“We believe this distressed cycle will continue,” offering opportunities for investors to continue to pick up bargains, they wrote. “The end is not near.”