Junk Sets October Record, Mortgage Bonds Rally: Credit Markets

Sales of junk bonds in the U.S. set a record for October as returns topped investment-grade debt and more borrowers were raised than cut. Government-backed mortgage bonds may beat Treasuries by the most in at least 10 years.

Fortescue Metals Group Ltd. and Calpine Corp. led speculative-grade companies issuing $33 billion of debt this month, according to data compiled by Bloomberg. The notes have gained 2.32 percent on average in October, compared with a loss of 0.16 percent for high-grade securities, Bank of America Merrill Lynch Index data show. Not since March have high-yield, high-risk securities outperformed by such a wide margin.

Investors have driven relative yields down to the lowest in five months on confidence the Federal Reserve will flood the economy with money, allowing the neediest borrowers to access capital and refinance debt. The rally is robust enough to extend into next year, said James Murren, chief executive officer of Las Vegas-based casino operator MGM Resorts International, which sold $500 million of notes rated CCC+ on Oct. 25.

“The bond market will get better,” Murren said yesterday in an interview at Bloomberg headquarters in New York. “People are going to start to have a more positive outlook toward 2011. They’re going to be searching for yield and they’re going to go down the rating scale and that’s going to benefit companies like us.”

Ratings Raised

The U.S. economy grew at a 2 percent annual rate in the third quarter as consumer spending climbed the most in almost four years, Commerce Department figures showed today in Washington.

Amid signs the expansion will continue, Standard & Poor’s raised its ratings on 20 junk issuers this month, while cutting 12, data compiled by Bloomberg show. The extra yield investors demand to hold speculative-grade bonds rather than Treasuries narrowed to 577 basis points, or 5.77 percentage points, yesterday from this year’s peak of 727 in June, the Bank of America Merrill Lynch U.S. High Yield Master II index shows.

Elsewhere in credit markets, spreads on company bonds worldwide were unchanged at 164 basis points, down from this year’s high of 201 on June 11, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. Yields averaged 3.486 percent, from 3.515 percent Oct. 27.

Colgate-Palmolive Co., the world’s largest toothpaste maker, may issue $438 million of debt as soon as today in a two- part offering, according to a person familiar with the transaction.

Default Swaps

The sale may include $188 million of 5-year notes that yield 38 basis points more than similar-maturity Treasuries and $250 million of 10-year securities at a spread of 53 basis points, said the person, who declined to be identified because terms aren’t set.

The Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, increased 0.15 basis point to a mid-price of 94.15 basis points as of 12:50 p.m. in New York, according to index administrator Markit Group Ltd.

The index, which typically rises as investor confidence deteriorates and falls as it improves, touched the lowest in more than five months Oct. 26 at 92.5 basis points.

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, 0.01 percentage point, equals $1,000 annually on a contract protecting $10 million of debt.

The $5.3 trillion market for mortgage bonds guaranteed by government-supported Fannie Mae and Freddie Mac and federal agency Ginnie Mae rallied in October, after underperforming Treasuries for two straight months on refinancing concern.

Agency Mortgage Securities

The so-called agency mortgage securities have returned 105 basis points more than Treasuries with maturities similar to their projected average lives, according to Barclays Capital index data through Oct. 27. They trailed U.S. government debt by 52 basis points last month, the most since November 2008, just after the height of the global financial crisis.

Bond buyers returned to the debt, in part, as monthly reports confirmed refinancing by homeowners remains limited even amid record-low mortgage rates, according to Paul Jacob, director of research at broker Banc of Manhattan Capital.

Prepayment reports released on Oct. 6 “weren’t as scary as the market feared,” Jacob said in a telephone interview from Calabasas, California. “While October had faster speeds, it didn’t go bump in the night.”

‘Tapered Off’

The tightening in spreads on high-yield debt shows investors are betting the risk that the economy will slip back into recession has fallen to 14 percent, according to BNP Paribas Asset Management’s Martin Fridson. That’s compared with 33 percent on Aug. 27, when spreads were 681 basis points.

“The concern has tapered off somewhat because the economic indicators are more favorable and there’s less talk about a double-dip than there once was,” said Fridson, global credit strategist in New York, who started his career as a corporate debt trader in 1976. “There’s just not as much of a preoccupation with recessionary talk.”

Junk bonds are rated below BBB- at S&P and less than Baa3 by Moody’s Investors Service.

Fortescue, Australia’s third-largest producer of iron ore, sold $2.04 billion of five-year notes this week in the biggest offering of junk-rated U.S. dollar-denominated bonds by an Australian company, data compiled by Bloomberg show.

Fortescue Offering

The 7 percent notes due in November 2015 were priced to yield 575 basis points more than Treasuries. The iron ore miner sold $1.65 billion of notes in the U.S. currency in August 2006 at coupons as high as 10.625 percent. Moody’s assigned the latest notes a provisional grade of B1 and S&P ranked them B.

Proceeds of Fortescue’s latest bond sale will be used to repay bank loans, the company said in an Oct. 27 statement to the Australian stock exchange.

“We’ve pushed many of our clients into what we view as a very attractive market from a refinancing standpoint,” said Richard R.S. Smith, head of high-yield capital markets at Royal Bank of Scotland’s RBS Securities unit. “We think it’s going to continue as long as the U.S. government maintains a 10-year treasury rate below 3 percent.”

RBS helped managed the sale of MGM Resorts’s $500 million of six-year notes. The casino operator will use the proceeds to repay some of the $1.2 billion owed to lenders under its senior credit facility, MGM said in a statement distributed by PRNewswire.

Calpine

The 10 percent debt was priced to yield 10.25 percent, or 874 basis points more than Treasuries. The offering followed MGM Resorts’ $845 million sale of 10-year, 9 percent notes in March.

Calpine, based in Houston, sold $2 billion of February 2021 debt on Oct. 18, increasing the size of the offering from $1.5 billion. The 7.5 percent notes were priced to yield 495 basis points more than Treasuries.

U.S. junk bonds have gained 14.4 percent this year, compared with the record 57.5 percent in all of 2009. The 1.96 percent increase this month in the Bank of America Merrill Lynch Global High Yield & Emerging Markets Plus index exceeds gains on the Global Broad Market Corporate Index by 215 basis points, after outperforming by 233 basis points last month.

Global corporate bonds have lost 0.19 percent in October, after rising 0.22 percent in September and the worst performance since losing 0.4 percent in May. Year-to-date returns total 8.84 percent.

To contact the reporter on this story: Tim Catts in New York at tcatts1@bloomberg.net.

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net.

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