Oct. 31 (Bloomberg) -- Corporate debt markets in the U.S. and Europe endured their worst month as the credit crisis spread beyond financial firms to industrial companies amid the prospect of a global recession.

Corporate industrial bonds in October are set to post their steepest monthly loss on record, while the gaps between yields on those bonds and government debt soar by the most ever. Investors sold off the debt and pushed company borrowing costs higher as the world's largest economies began to contract, including France, Germany, Italy, the U.K. and the U.S.

``Economic fundamentals are pricing a long and deep recession with the probability of depression,'' said Andrea Cicione, a London-based credit strategist at BNP Paribas SA. ``We are witnessing a major unwinding of leverage and worsening of economic conditions.''

The cost of credit-default swaps on the Markit iTraxx Crossover Index surged as high as 925 basis points, up from 171 basis points before the crisis started last year, and a gauge of leveraged loan prices plummeted almost 20 percent.

Credit markets are at a virtual standstill even as central banks from the European Central Bank to the People's Bank of China cut borrowing costs, pumped more than $3 trillion into financial company bailouts and the Federal Reserve flooded money markets with dollars.

Corporate bond sales in Europe dropped to the lowest this year with 25.4 billion euros ($32.3 billion) of notes sold during the month, compared with 35.9 billion euros in September and 45.6 billion euros in August, according to data compiled by Bloomberg. U.S. investment-grade offerings fell to $21.6 billion, the slowest since July 2002, compared with $87.4 billion a year ago.

Economic Headwinds

Corporate non-financial bonds in Europe have lost 3.03 percent so far this month, the biggest decline since 1999, Merrill Lynch & Co.'s EMU Corporates, Non-Financial Index shows. U.S. industrial investment-grade bonds have lost 9.4 percent, according to Merrill's U.S. Industrial Corporates index. The extra yield investors demand to own the debt widened 203 basis points to 552 basis points, a faster pace than the overall market for investment-grade debt, the data shows.

U.S. investment-grade bonds have lost 7.4 percent so far in October, putting them on a pace for their worst month in at least 35 years, according to Merrill's U.S. Corporate Master index.

``This month is the worst-performing month for credit and it is not going to get better because we are going into continued economic headwinds,'' said Suki Mann, a credit strategist at Societe Generale SA in London. ``In terms of issuance, this October was the second-worst for non-financial corporates since the single currency came in.''

Government-Backed Bonds

Some credit markets began to recover after the U.S. government announced plans to invest in banks and guarantee some of their debt and deposits on Oct. 14. Spreads on bank and speculative grade bonds narrowed the most on record that day.

In the U.K. the market was only boosted by sales under the government's 250 billion-pound ($404 billion) state-guaranteed bond program. Barclays Plc, Britain's second-biggest bank, raised 3 billion euros under the plan and Bank of Scotland, a unit of HBOS Plc, sold two issues of 3 billion euros and 600 million pounds. No U.S. bank has used a similar guarantee to issue bonds.

The extra yield on European investment-grade company debt over government securities climbed 90 basis points to 400 basis points during October, the widest gap since Merrill started collating the daily data in 1999. The spread was 88 basis points last year. A basis point is 0.01 percentage point.

Spreads on U.S. investment-grade bonds widened 162 basis points this month to 617 basis points, about the highest on record, according to Merrill's U.S. Corporate Master index.

Default Protection

The cost of default protection in the credit-default swap market surged after the bankruptcy of Lehman Brothers Holdings Inc. on Sept. 15 and the collapse of the Icelandic banking system. Lehman debt was settled at 8.625 cents on the dollar.

Credit-default swaps on the Markit iTraxx Crossover Index of 50 companies with mostly high-risk, high-yield credit ratings rose by a record 197.25 basis points to 770, according to JPMorgan Chase & Co. prices at 10 a.m. in London. The index traded at 925 basis points Oct. 24.

Contracts on the benchmark European investment-grade index climbed 32.25 basis points to 150, the biggest monthly rise since February, after reaching a record 195 this week, JPMorgan prices show.

``Since the demise of Lehman -- it was only six weeks ago -- we've seen the most turbulent markets in history,'' said Bill Blain, a broker at KNG Securities in London. ``We've seen a fundamental reappraisal of markets.''

Loan Prices

The price of loans used to fund leveraged buyouts tumbled as asset sales by hedge funds and private equity investors flooded onto the market. Holdings were dumped because of clauses in funds' borrowing agreements that require them to raise money when prices drop below a set level, according to Standard & Poor's.

In one sale, Sankaty Advisors LLC, an investment unit of Boston-based private equity fund Bain Capital LLC, offered $341 million of buyout loans including debt used to fund the takeover of Manchester United, Europe's club soccer champions, and U.K. bingo hall operator Gala Coral Group Ltd.

The Markit iTraxx LevX Index of credit-default swaps linked to loans of 75 European companies fell as much as 18.85 basis points to 79.2 in London this month according to prices provided by Markit Ltd. The index traded at 87.5 today, according to Morgan Stanley.

``Leveraged loan prices could fall as far as the low 60s before we see a recovery,'' Mahesh Bhimalingam, head of high- yield and leveraged finance strategy at Barclays Capital in London said in an interview. ``The size of the price drops has slowed, but there are still going to be some more leveraged positions getting unwound.''

To contact the reporters on this story: Shelley Smith in London at ssmith118@bloomberg.net; Abigail Moses in London amoses5@bloomberg.net; Bryan Keogh in New York at bkeogh4@bloomberg.net

Last Updated: October 31, 2008 12:41 EDT