Energy Bonds Outperform as BP Shrugs Off Junk-Debt Stigma: Credit Markets

Energy-company bonds are beating the broader market this quarter as BP Plc shrugs off its junk-debt stigma on speculation its losses from the Gulf oil spill are contained.

Energy bonds have returned 4.63 percent since July, the most of any industry in the Bank of America Merrill Lynch Global Broad Market Corporate Index. It made gains after underperforming the market in the previous three-month period. BP’s bonds pay an average 2.55 percentage points more than benchmark government debt, close to the relative yield on a typical note with the second-lowest investment-grade rating.

Fitch Ratings lifted BP’s credit grade by three steps yesterday, before the London-based oil company published its internal investigation of the April 20 rig explosion, in which it said contractors Transocean Ltd. and Halliburton Co. should also share the blame. The spill roiled other energy companies’ bonds in the two months that followed, causing them to slump more than the broader market.

“The energy space is back in favor and strongly outperforming” other industries, said Justin D’Ercole, head of the Americas investment-grade syndicate at Barclays Capital in New York.

Improved sentiment about the industry and plunging corporate borrowing costs encouraged energy companies to sell bonds. Borrowers marketing issues today include Nabors Industries Ltd., the largest onshore petroleum driller; Nevada Power Co.; and Korea Hydro & Nuclear Power Co., according to data compiled by Bloomberg.

Energy Bond Returns

Energy-company bond returns this quarter compare with 4 percent for insurers’ debt, the second-best industry, and 3.11 percent for all corporate securities, Bank of America index data show.

Elsewhere in credit markets, a gauge of corporate credit risk in the U.S. fell to the lowest in more than four weeks. U.S. mortgage financier Freddie Mac sold $5 billion of five-year reference notes and Valeant Pharmaceuticals said it plans to sell senior unsecured notes.

The Markit CDX North America Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses on corporate debt or to speculate on creditworthiness, declined 1.8 basis points to a mid-price of 103.6 basis points as of 12:32 p.m. in New York, according to Markit Group Ltd. The index, which was trading at the lowest since Aug. 9, typically falls as investor confidence improves and rises as it deteriorates.

Freddie Mac Sale

Freddie Mac sold its $5 billion of five-year reference notes at higher yields relative to Treasuries than in its last similar sale.

The securities yield 1.81 percent, or 29.5 basis points more than similar-maturity government debt, the McLean, Virginia-based company said today in an e-mailed statement. In January, Freddie Mac sold $4 billion of its five-year reference notes at a spread of 27.5 basis points.

The cost of protecting European company debt against losses fell to close to the lowest level in a month, with the Markit iTraxx Europe Index declining 2.3 basis points to 106.4 as of 12:23 p.m. in New York, according to Markit Group Ltd.

The credit-default swap indexes typically decline as investor confidence improves and rise as it deteriorates. 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 investments.

Spread Narrows

The extra yield investors demand to own corporate versus government debt fell 1 basis point to 177 basis points, Merrill’s Global Broad Market Corporate Index shows. Yields rose to 3.553 percent.

Issuance is soaring with investment-grade yields at 3.87 percent, close to the Aug. 24 level that was the lowest in a history dating to October 1986, according to Bank of America Merrill Lynch’s U.S. Corporate Master index.

Leveraged loan prices rose yesterday, with the S&P/LSTA U.S. Leveraged Loan 100 Index up 0.11 cent to 89.54 cents on the dollar. The index, which tracks the 100 largest dollar- denominated first-lien leveraged loans, returned 4.4 percent this year.

Energy bond spreads have narrowed 34 basis points this quarter to 181 basis points, compared with a decline of 19 basis points for the broader company debt market, according to Bank of America Merrill Lynch index data.

BP Upgrade

Fitch said its upgrade of BP’s rating to A yesterday reflected an “end to the threat of further leaks” and better “visibility” on the oil company’s liabilities. The New York- based rating firm, which gave BP its second-highest grade of AA+ until June, had cut its rating twice to as low as BBB because of uncertainty over the cost of the spill. Fitch said yesterday the bill for the accident will be between $35 billion and $67.5 billion.

Standard & Poor’s rates BP debt an A, the sixth-highest investment grade. Moody’s Investors Service ranks it at the same level with an A2 rating.

BP’s average 266 basis-point bond spread is close to the 246 basis points for notes rated BBB -- two steps above junk -- in Bank of America Merrill Lynch’s global corporate index. The U.K. company’s debt paid spreads averaging 650 basis points on June 25, compared with a spread of 638 basis points for securities graded B+, or four steps into junk territory.

BP’s investigation of the Gulf of Mexico oil spill, released on the company’s website yesterday, cited at least eight errors of judgment and equipment failures that allowed natural gas to erupt from the Macondo well off the Louisiana coast.

Bonds Rise

The company’s $1 billion of 4.75 percent notes due in 2019 climbed 1 cent to a three-month high of 99.63 cents on the dollar today, according to Trace, the bond price reporting system of the Financial Industry Regulatory Authority.

U.S. bond-research firm Gimme Credit raised its recommendation for BP to “stable” from “deteriorating” yesterday, citing the “end of the Macondo well threat” as well as debt reduction and progress in selling $30 billion of assets.

The research firm also cited credit lines the oil company is putting in place to help fund the cleanup. BP arranged $12 billion of bank credit lines in the second quarter, and also pledged oil sales from Angola and Azerbaijan as it sought $5 billion of loans in August, according to data compiled by Bloomberg.

Energy bonds were the third worst-performing debt behind banks and insurers in the second quarter, returning just 1.44 percent, compared with the 2.08 percent gain for the broader corporate market, Bank of America Merrill Lynch indexes show.

“There’s now a lot more certainty because the leakage has been stopped and the pollution is not as catastrophic as might have been expected,” said Christian Kleindienst, an energy- industry analyst at UniCredit SpA in Munich who has an “overweight” view of the sector. “More and more we come to such a stage where investors tend to think this is a past event.”

To contact the reporter on this story: Bryan Keogh in London at bkeogh4@bloomberg.net

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