BP Trades as Junk, Credit-Default Swaps Invert: Credit Markets
BP’s $3 billion of 5.25 percent notes due in 2013 fell as low as 89.94 cents on dollar yesterday, a record, pushing the yield to 7.57 percentage points more than Treasuries. The spread compares with an average of 7.26 percentage points for junk bonds, Bank of America Merrill Lynch indexes show. The cost to protect $10 million of BP debt for a year with credit-default swaps more than doubled over the past two days to $734,000, according to CMA DataVision. It was $29,000 on April 30.
“That’s just pure out panic,” said Michael Donelan, who oversees $3.5 billion of bonds at Ryan Labs Inc. in New York. “That’s like, ‘Get me out of here now.’ What the market is pricing in now is increased regulatory oversight and heavy, heavy punitive damages.”
Debt investors are losing confidence in London-based BP as the company fails to contain the oil leak in the Gulf of Mexico. BP said June 7 it has spent $1.25 billion, or about $27 million a day, related to the accident. Credit Suisse Group AG estimated the cost may reach $37 billion.
Credit-default swaps on BP implied a Ba2 rating for the company as of June 8, nine steps lower than its actual Aa2 grade at Moody’s Investors Service, based on data from the ratings firm’s capital markets research group. The implied rating was as high as A3 on May 28, the data show. Junk bonds are rated below Baa3 by Moody’s and lower than BBB- by Standard & Poor’s.
Banks and other trading partners may be buying short-term protection from losses on derivatives they have with BP, said Tim Backshall, chief strategist at Credit Derivatives Research LLC in Walnut Creek, California.
One-year credit swaps on BP debt are trading 249 basis points more than the annual cost to protect the bonds for five years in a so-called inverted curve, according to CMA prices. Derivatives used for hedging foreign-exchange risk used by companies such as BP tend to be shorter-dated, Backshall said.
Contracts protecting BP’s debt for five years rose 84 basis points to 471, CMA prices show. The swaps climbed to a record earlier. One-year credit-default swaps for BP added 207 basis points to 720, CMA prices show.
Elsewhere in credit markets, two-year interest-rate swap spreads, a measure of bank risk, fell to the lowest in three weeks. Fannie Mae, the government-supported mortgage company, sold $3 billion of benchmark notes, while Citigroup Inc. issued $1.88 billion of securities yesterday.
The difference between yields on two-year Treasuries and the rate to convert fixed payments to floating narrowed 3.6 basis points to 37.7. Two-year interest-rate swap spreads soared to a 13-month high of 52.25 basis points on May 24 as investors fled all but the safest government securities. The spread dropped to 9.63 on March 24, the narrowest since 1993.
The average spread on Merrill’s Global Broad Market Corporate index rose 1 basis point to 199 basis points, or 1.99 percentage point, yesterday. The yield was 4.08 percent.
Fannie Mae’s five-year notes yield 2.437 percent, or 0.39 percentage point more than similar-maturity Treasuries, the Washington-based company said today in a statement. Citigroup’s 6 percent debt maturing in 2013 yields 5.43 percent and pays a 425 basis point spread.
Spreads on emerging-market bonds narrowed 13 basis points to 325 basis points, according to JPMorgan Chase & Co.’s Emerging Market Bond index. The gap has ranged from a low of 230 basis points on April 15 to as high as 346 on May 20.
The cost of protecting European corporate bonds from default declined to the lowest in almost a week, with credit- default swaps on the Markit iTraxx Crossover Index of 50 mostly junk-rated companies dropping 15 basis points to 599.3, according to Markit Group Ltd. prices at 4:33 p.m. in London.
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.
BP’s stock plunged to the lowest in 13 years in London trading today, dropping as much as 12 percent to 345.15 pence. The shares have lost 44 percent of their value since April 20, the day of the Deepwater Horizon rig explosion that killed 11 workers and triggered the worst oil leak in U.S. history.
Energy Bond Losses
Losses on bonds of BP, The Woodlands, Texas-based Anadarko Petroleum Corp. and Transocean Ltd. of Vernier, Switzerland, the other two companies involved in the oil spill, have sparked a 2.34 percent drop in Bank of America Merrill Lynch’s U.S. Corporate Energy index since April. A global broad corporate bond index is down 0.24 percent in the same period.
BP has seven bonds with a face value of $10.6 billion in the Bank of America Merrill Lynch energy index. The spread on the bonds widened an average of 162 basis points to 541 basis points yesterday. The gap on the index is 239.
Anadarko bond spreads increased 37 basis points to 501 on average, and Transocean surged 42 to 539.
Ian MacDonald, an oceanographer at Florida State University in Tallahassee, estimated the well is leaking 26,500 barrels to 30,000 barrels a day into the Gulf, six times more than the figure used by BP and the government from April 28 to May 27.
“The piece of news that seems to have broken the camel’s back was an increase of estimated spill volumes,” said Guy Lebas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia.
Investors should be “underweight” oil and gas debt, a change from “marketweight,” Lebas wrote in a June 7 report, amid greater regulation and a halt to drilling projects.
Pressure on Dividend
President Barack Obama said this week he would have fired BP Chief Executive Officer Tony Hayward for saying he wanted to end the leak because he wanted “his life back.” Obama said he has made three trips to the Gulf to find out who to hold responsible, “so I know whose ass to kick.” Lawmakers led by Representative Peter Welch, a Vermont Democrat, wrote to Hayward urging him to stop paying dividends and cancel an advertising campaign in the U.S. until the cleanup is done. BP said today it “faces this situation as a strong company.”
BP shareholders got $10 billion in payouts last year. Should BP keep the same dividend this year as in 2009, the ratio of payouts to share price will be more than 10 percent, the highest among 18 of the company’s peers tracked by Bloomberg.
As recently as the end of April, BP bond spreads averaged 46 basis points. The increase amounts to an extra $33 million in interest a year on every $1 billion BP borrows. BP has about $24.9 billion of debt, with $1.32 billion due this year and $5.96 billion maturing in 2011, according to data compiled by Bloomberg.
The 5.25 percent BP notes due in 2013 fell 5.75 cents to yield 7.89 percent as of 5:01 p.m. in New York yesterday, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. That compares with 9.45 percent for high-yield corporate debt, according to Bank of America Merrill Lynch index data.
“It doesn’t make sense” for the bonds to trade at junk levels, said BP spokesman Toby Odone in London. “We are generating significant cash flow because the oil price is higher than $60 a barrel. We have a strong asset base.”
Anadarko’s $1.75 billion of 6.45 percent bonds due in 2036 tumbled 5.75 cents to 76.5 cents for a yield spread of 4.63 percentage points yesterday, Trace data show.
Transocean’s $1 billion of 6.8 percent securities due in 2038 fell 4.75 cents to 80.25 cents, for a spread of 4.58 percentage points.
Simon Ballard, senior credit strategist at RBC Capital Markets, said the decline in BP’s credit was a “buying opportunity” rather than a sign the company is headed for default.
“BP is trading at spreads that are disproportionate with its current rating,” London-based Ballard said in an interview. “We don’t think BP is going to default. If anything these levels are a buying opportunity.”
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