Bond Distress Tumbles to Lowest Since '07 on Refinancings: Credit Markets

The percentage of corporate bonds considered in distress is the lowest in more than three years as the U.S. economic recovery gives fixed-income investors the confidence to lend to the riskiest borrowers.

The number of junk bonds trading at yields at least 10 percentage points more than government debt fell to 215, or 8.6 percent of the total, as of Jan. 7, the least since October 2007, according to Bank of America Merrill Lynch’s Global High- Yield Index. Spreads on debt of Las Vegas-based Caesars Entertainment Corp., the world’s biggest casino operator, and credit-card processor IPayment Inc. are below the threshold for the first time since 2008.

Confidence is improving at a faster pace than after the last recession ended in November 2001, as Goldman Sachs Group Inc. expects economic growth to lead to “rapid” gains in U.S. corporate profits. Back then, the distress ratio took 26 months to drop to 7 percent.

“We’re going to see positive growth,” said Matthew Freund, senior vice president of investment portfolio management at USAA Investment Management Co. in San Antonio, where he helps oversee $46 billion. “It’s going to be enough to satisfy the markets.”

High-yield bonds, rated below Baa3 by Moody’s Investors Service and lower than BBB- by Standard & Poor’s, are among JPMorgan Chase & Co. strategists’ top picks for 2011. They recommend “overweighting” bonds with CCC ratings, or holding a greater percentage of the debt than is contained in benchmark indexes.

Europe Turmoil

Optimism in the U.S. contrasts with the sovereign debt turmoil in Europe that has kept bond distress levels elevated.

America’s distress ratio fell to 7.1 percent from a 2010 high of 15 percent reached in June. In Europe, the ratio dropped to 19 percent from as high as 32 percent that same month. Most of Europe’s distressed bonds are subordinated debt from financial companies.

Elsewhere in credit markets, the extra yield investors demand to own corporate debt worldwide instead of government securities was 167 basis points, or 1.67 percentage points, on Jan. 7, down from 169 at the end of 2010, Bank of America Merrill Lynch data show. Investment-grade spreads in the U.S. stood at 163, after dropping to 162, the narrowest since May. Yields overall worldwide were 3.89 percent.

Credit Swaps Rise

The cost of protecting U.S. corporate bonds from default climbed to the highest level in a month.

The Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, increased 1.7 basis points to a mid-price of 90.2 basis points as of 11:31 a.m. in New York, according to index administrator Markit Group Ltd.

The Markit index, which typically rises as investor confidence deteriorates and falls as it improves, is at the highest level since reaching 90.7 basis points on Dec. 6.

In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings climbed 3.5 to 115.9, the highest since Nov. 30.

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.

MGM Resorts International, the biggest casino owner on the Las Vegas Strip, plans to sell $1.1 billion of senior secured notes to refinance debt of its CityCenter Holdings LLC joint venture with Dubai World, the company said in a statement distributed by PR Newswire.

Economic Growth

MGM Resorts may issue $500 million of five-year, first-lien notes as well as $600 million of six-year, second-lien securities that can pay interest in cash or additional debt, according to a person familiar with the offering. The sale may occur as soon as this week, said the person, who declined to be identified because terms aren’t set.

The U.S. economy will grow 2.6 percent in 2011 and 3.2 percent in 2012, compared with 1.5 percent and 1.8 percent for the 17 nations that use the euro, according to separate Bloomberg polls. Employers in the U.S. added more jobs for a third month in a row in December, helping the unemployment rate fall to a 19-month low of 9.4 percent from a quarter-century high of 10.1 percent in October 2009, according to Labor Department data released Jan. 7.

‘More Confident’

“Investors in the U.S. are growing more confident in the recovery, while in Europe, sovereign fears continue to weigh on markets,” said Suki Mann, a credit strategist at Societe Generale SA in London.

U.S. growth and a large “output gap” is likely to lead to corporate profit gains of 20 percent to 25 percent this year and 15 percent to 20 percent in 2012, Goldman Sachs economists led by New York-based Jan Hatzius said in a Jan. 6 client note. The gap is the disparity between a country’s current growth rate and its potential.

The trailing 12-month global speculative-grade default rate fell to a two-year low of 3.1 percent in the fourth quarter, from 13.1 percent a year earlier, Moody’s said Jan. 7. It said the rate may reach as low as 1.9 percent by December.

“The story of 2010 is how few defaults were actually recorded,” Albert Metz, a managing director of credit policy research at Moody’s, said in the report.

Defaults Fall

As defaults fell, the so-called distress ratio dropped from 11 percent at the end of November and 16 percent in August, Bank of America Merrill Lynch index data show. The rate reached a record-high 84 percent in November 2008.

The extra yield investors demand to own Caesar’s 10.75 percent notes due in 2016 rather than government debt shrank to 9.64 percentage points on Jan. 3 from more than 83 percentage points in February 2009, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

The spread on Nashville, Tennessee-based IPayment’s 9.75 percent debt due in 2014 tightened to 9.64 percentage points on Jan. 5 from as high as 26.73 percentage points in March 2009. That’s the smallest spread since June 2008.

“Corporate profitability is near record highs, the high- yield bond default rate is near record lows, and loan delinquency rates are stabilizing,” JPMorgan strategists said in a Jan. 5 report. The decline in distress is further “reinforcing the fundamentals” of economic recovery by helping companies raise money and avoid default, Grace Koo, a strategist at JPMorgan in London, said in an interview.

Spreads to Shrink

Spreads on U.S. high-yield debt should shrink about 51 basis points from current levels, she said. The bonds may return 10 percent this year as spreads contract as much as 150 basis points on “favorable liquidity conditions,” according to Bank of America Merrill Lynch strategists including Jeffrey Rosenberg in New York.

The extra yield over government debt for junk bonds fell to 526 basis points on Jan. 5, the least since November 2007, according to Bank of America Merrill Lynch’s Global High-Yield Index. The spread climbed to 536 basis points Jan. 7.

Distress has eased as more junk-rated companies are able to tap the bond markets for financing, said Peter Ehret, the Houston-based head of high-yield investments and a senior money manager at Invesco Ltd., which oversees $611 billion in assets. Global high-yield sales soared 74 percent to $366.8 billion in 2010, according to data compiled by Bloomberg.

“That’s allowing a lot of refinancing, which is taking risk down,” he 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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