Bond Distress at 5-Month Low as Junk Rallies: Credit Markets

The percentage of corporate bonds considered in distress fell to a five-month low as record sales of high-yield debt and declining borrowing costs convince investors the riskiest companies can pay their lenders.

The number of speculative-grade companies worldwide with yields at least 10 percentage points more than government bonds declined to 290, or 12 percent of the total, the lowest share since April and down from 15.9 percent at the end of August, according to Bank of America Merrill Lynch index data.

Junk-rated borrowers globally sold a record $98.9 billion of bonds last quarter as investors sought higher relative yields, helping the weakest companies shore up their balance sheets. Defaults by high-yield issuers fell to 4 percent last month from 6.2 percent in June, Moody’s Investors Service said yesterday.

“There’s a tremendous yield hunger that isn’t satisfied and that’s pushing up the prices in all the bottom-tier names,” said Margaret Patel, who oversees about $1 billion of assets as a fund manager at Wells Fargo & Co. in Boston. “If you want capital appreciation, there’s only an ever shrinking universe to get that sort of yield.”

Investors poured $480.2 billion into debt mutual funds in the two years ended in June, more than went into stock funds during the Internet bubble, according to the Washington-based Investment Company Institute.

Deutsche Bank Offering

Debt sales, distressed exchanges and other lending has helped high-yield companies push out their maturities, slashing the amount of bonds and loans they have coming due between 2011 and 2013 by 26 percent to $281.4 billion since last year, according to Bank of America data.

Elsewhere in credit markets, the extra yield investors demand to own company bonds instead of similar-maturity government debt fell 1 basis point to 170 basis points, or 1.7 percentage points, the lowest since May 13, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. Yields averaged 3.391 percent.

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, fell 1.6 basis points to 96.71 basis points as of 11:43 a.m. in New York, according to index administrator Markit Group Ltd. That’s the lowest since May 3.

The index typically declines as investor confidence improves and rises 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 debt.

Junk Bond Sales

At least $13.2 billion of junk bonds have been sold this month, bringing the global total to an all-time high of $263.5 billion, 26 percent higher than the full-year record set in 2009, Bloomberg data show. Junk bond sales in the U.S. have reached $208.9 billion this year, the data show.

“This is obviously a case of too much money chasing too few good bonds,” said Don Ross, who helps oversee $9.5 billion of assets as global strategist for Titanium Asset Management Corp. in Cleveland. “It’s just money changing hands and corporations being the net gainer by being able to issue cheaper and have better balance sheets. In the long run that will help the economy, but holy mackerel, at what cost?”

U.S. junk bonds yield 430 basis points more than investment-grade debt, compared with 216 basis points in June 2007 before the credit crisis, Bank of America Merrill Lynch index data show. Prices of the speculative-grade securities have climbed to 101.82 cents on the dollar from as low as 55 cents in December 2008. The bonds reached face value last month for the first time since June 2007.

Investors put $2.6 billion into distressed debt funds in the first half of the year, according to Hedge Fund Research Inc. in Chicago.

‘Very Nice Opportunities’

U.S. distressed bonds have returned 16.3 percent in 2010, following gains of 117 percent in all of 2009, according to Bank of America Merrill Lynch’s U.S. High-Yield Distressed Index. The entire market for high-yield bonds is up 13.7 percent.

“We are finding very nice opportunities in the secondary market,” said Marvin Barth, chief investment strategist at Tennenbaum Capital Partners LLC in Santa Monica, California. “We’re having a great opportunity to originate very nice deals for us that pay very high rates of return and also help these companies grow.”

Tennenbaum, which had been seeking about $1 billion to buy distressed debt, also lends directly to “middle-market” companies that don’t have as much access to capital markets, Barth said on Bloomberg Television’s “InBusiness.”

The percentage of distressed securities rose as high as 16.1 percent in May from a 22-month low in April of 9.2 percent, as Europe’s sovereign debt crisis led investors to flee the riskiest assets, Bank of America Merrill Lynch index data show.

Falling Default Rate

Moody’s forecasts the global corporate default rate will fall to 2.7 percent by year-end, dropping to 2 percent by the third quarter of 2011.

“Defaults have plunged,” said Patel, who manages Wells Fargo’s Advantage Diversified Capital Builder Fund and Advantage Diversified Income Builder Fund. “The credit markets have been extremely favorable. Some companies that have been borderline credit quality have been able to refinance.”

Moody’s said in an Oct. 4 report that it raised the speculative-grade liquidity ratings of eight companies in September compared with four cuts, the 17th month in a row in which upgrades outpaced downgrades.

‘Within Shouting Distance’

Investors are demanding an extra 606 basis points to own junk bonds rather than government debt, the lowest since May 5, five days before the European Union announced a $1 trillion bailout of its most indebted nations, according to Bank of America Merrill Lynch’s Global High-Yield Index. Absolute yields fell to 7.83 percent yesterday from this year’s high of 9.62 percent on June 10.

High-yield spreads in the U.S., which fell yesterday to 613 basis points, are “within shouting distance” of the historical average of 598 basis points, a milestone that doesn’t indicate the market has “run too far too fast,” Martin Fridson, global credit strategist at BNP Paribas Asset Management, said Oct. 6 in an e-mail.

The default rate implies a spread of 484 basis points, wrote Fridson, who is based in New York and began his career as a corporate debt trader in 1976.

“Investors are being well compensated for risk and talk of a bubble in high-yield bonds is misguided,” Fridson said.

To contact the reporters on this story: Bryan Keogh in London at bkeogh4@bloomberg.net; John Detrixhe in New York at jdetrixhe1@bloomberg.net

To contact the editors responsible for this story: Paul Armstrong at parmstrong10@bloomberg.net; Alan Goldstein at agoldstein5@bloomberg.net

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