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Junk Bond Stress at Record Low as Defaults Slow: Credit Markets

U.S. speculative-grade companies are in the best position ever to meet their debt obligations as investors pour a record $43 billion into high-yield mutual funds and borrowers boost the cash held on balance sheets.

Moody’s Investors Service said Aug. 1 its Speculative-Grade Liquidity-Stress index, which falls as corporations’ ability to manage cash needs improve, dropped to 3.1 percent in July, beating the previous record low of 3.3 percent in May. The New York-based ratings firm sees the U.S. default rate peaking at 4 percent in October before falling to 3 percent by June 2013, below the historical average of 4.6 percent since 1992.

While the unemployment rate has held above 8 percent since February 2009, demand for high-yield, high-risk bonds has grown as investors speculate that the Federal Reserve will keep interest rates near zero through late 2014 to bolster the economic recovery. Credit Suisse Group AG boosted its forecast for returns this year to a range of 8 percent to 11 percent from 7 percent to 10 percent.

“The access to the market is mainly a function of a lot of demand for yield, but investors would not buy with the same enthusiasm if they really thought there were credit problems looming,” Martin Fridson, global credit strategist at BNP Paribas Investment Partners in New York, said in a telephone interview. “The companies are genuinely in good shape.”

Opportunistic Issuance

Junk-bond funds received $9.32 billion of inflows in July, the most since February, sending the 2012 total 30 percent higher than the previous full-year record, according to EPFR Global in Cambridge, Massachusetts. High-yield companies may face tougher borrowing conditions if European policy makers fail to curb soaring yields and the U.S. economy weakens, Moody’s said in the Aug. 1 report.

“Liquidity in the market, just in general, it can change on a dime,” Scott Roth, U.S. high-yield fund manager at Babson Capital Management LLC, which oversees $149 billion in assets, said in a telephone interview. “There will be times where it will be difficult to finance, and I think that’s why when the market is open for business, which it is right now, companies will need to be opportunistic.”

Elsewhere in credit markets, Altria Group Inc. (MO) and Celgene Corp. led borrowers issuing $12.6 billion of bonds yesterday in the most active start to the week since March 19, according to data compiled by Bloomberg. U.S. banks are relaxing their terms on credit cards and lending for autos and commercial real estate, the Federal Reserve said. Software provider Ceridian Corp. is seeking a $342 million loan to refinance debt.

Swap Spreads

The U.S. two-year interest-rate swap spread, a measure of debt market stress, fell 1.36 basis points to 19.39 basis points. The gauge narrows when investors favor assets such as corporate bonds and widens when they seek the perceived safety of government securities.

The cost of protecting corporate debt from default in the U.S. fell to an almost three-month low, with the Markit CDX North America Investment Grade Index of credit-default swaps, which investors use to hedge against losses or to speculate on creditworthiness, declining 0.8 basis point to a mid-price of 102.8 basis points as of 5:09 p.m. in New York, according to prices compiled by Bloomberg. That’s the lowest level since the gauge touched 100.9 on May 8.

Tobacco Bonds

In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings fell 2 to 147.7. In the Asia- Pacific region, the Markit iTraxx Asia index of 40 investment- grade borrowers outside Japan climbed 1 basis point to 149.5 as of 8:12 a.m. in Singapore, Royal Bank of Scotland Group Plc prices show.

The indexes typically fall 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 debt.

Bonds of Caracas-based Petroleos de Venezuela SA were the most actively traded dollar-denominated corporate securities by dealers, with 214 trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Altria sold $1.9 billion of 2.85 percent, 10-year notes to yield 130 basis points more than similar-maturity Treasuries and $900 million of 4.25 percent, 30-year bonds with a 168 basis- point spread, Bloomberg-compiled data show. The debt may be rated Baa1 by Moody’s Investors Service, three levels above speculative grade, the data show.

Lending Standards

Celgene, the maker of cancer-fighting drugs Istodax and Abraxane, sold $1.5 billion of bonds in its first offering since October 2010. The company issued $500 million of 1.9 percent, five-year notes to yield 130 basis points more than Treasuries and $1 billion of 3.25 percent, 10-year debt at 170 basis points, Bloomberg data show.

Companies from the most creditworthy to the riskiest are tapping debt markets after yields on dollar-denominated bonds reached a record low 3.9 percent on Aug. 2, down from 4.8 percent at the end of 2011, Bank of America Merrill Lynch index data show. Corporate issuers have sold $813 billion of debt in the U.S. this year, up 3.4 percent from last year, data compiled by Bloomberg show.

The Fed said yesterday in Washington in its quarterly survey of senior loan officers that: “Domestic banks, on balance, continued to report having eased their lending standards across most loan types over the past three months,”

‘Additional Accommodation’

Banks in the U.S. are lending the most since the recession ended in June 2009, supporting an economy burdened by 8.3 percent unemployment. Fed policy makers including Chairman Ben S. Bernanke weighed the results of the survey at their July 31-Aug. 1 meeting at which they said they “will provide additional accommodation as needed” to support the economy.

The Standard & Poor’s/LSTA U.S. Leveraged Loan 100 index added 0.09 cent to 94.60 cents on the dollar. The measure, which tracks the 100 largest dollar-denominated first-lien leveraged loans, has returned 6.8 percent this year.

Leveraged loans and high-yield bonds are rated below Baa3 by Moody’s and lower than BBB- by S&P.

Ceridian’s term loan, due in May 2017, will pay interest at 5.75 percentage points more than the London interbank offered rate, according to a person with knowledge of the transaction who declined to be identified because the terms are private.

The business services provider owned by Thomas H. Lee Partners LP is proposing to sell the loan at 98 cents on the dollar, the person said, reducing proceeds for the Minneapolis- based company and boosting the yield to investors.

Ceridian Loan

In emerging markets, relative yields fell for a second day, declining 2.6 basis points to 321.1 basis points, or 3.21 percentage points, according to JPMorgan Chase & Co.’s EMBI Global index. The measure has averaged 374 basis points this year.

The record low on Moody’s liquidity-stress index follows a decline in the number of companies with liquidity ratings of SGL-4, the lowest speculative-grade level, to the fewest since November 2005, Moody’s analysts Tom Marshella, Keith Foley, John Puchalla and Adam McLaren wrote in the report.

While two companies, Patriot Coal Corp. and Cinram International Inc. had their ratings withdrawn after filing for bankruptcy, Casella Waste Systems Inc. (CWST) and GeoEye Inc. (GEOY) had their liquidity grades raised to SGL-3.

Cash Flow

Free cash-flow at Rutland, Vermont-based Casella rose to $3.6 million in the fiscal quarter ended April 30, compared with negative cash flow of $23.4 million a year earlier. Free cash flow at GeoEye, the company being purchased by DigitalGlobe Inc. (DGI), narrowed to negative $16.4 million in the first quarter of 2012 from negative $53.3 million a year earlier, Bloomberg data show.

“Over the past couple of years, since the worst part of the downturn, cash flow has generally been improving,” Puchalla said in a telephone interview. “Our forecast for the default rate is that it will remain relatively low by historical standards over the next year, and it gives investors some comfort, at least in the near term, investing in higher yielding bonds.”

The index is calculated by dividing the number of companies rated SGL-4 by the total number in the index. When the number of companies assigned the lowest speculative-grade liquidity ranking falls, the measure also declines. The gauge, which falls as corporations’ ability to manage cash needs improves, has plunged from a high of 20.9 percent in March 2009.

Default Rate

The trailing 12-month default rate for global speculative- grade companies was 2.7 percent at the end of the second quarter, 2.1 percentage points below the historical average of 4.8 percent, according to a July 10 report from Moody’s.

High-yield bonds have returned 9.66 percent this year, including reinvested interest, Bank of America Merrill Lynch indexes show, compared with 8.99 percent for the Dow Jones Industrial Average when including dividends.

“Just with the dearth of yield out there, there continues to be a high level of demand” for riskier securities, Brian Nold, senior high-yield portfolio manager at Seix Investment Advisors LLC and sub-adviser of the RidgeWorth Seix High Yield Fund, said in a telephone interview. “It’s created the opportunity for companies to come to the market and access the capital markets.”

U.S. junk-bond issuance rose to $22.2 billion last month, the most since April, Bloomberg data show. Sales this year have totaled $174.3 billion.

Difficult Refinancing

The increased demand for riskier assets has driven down yields on junk-rated debt to within 30 basis points of the all- time low. Yields dropped to 7.45 percent yesterday, compared with a record low of 7.19 percent set on May 19, 2011, according to the Bank of America Merrill Lynch U.S. High-Yield Master II bond index.

While high-yield companies are benefiting from those lower rates, they aren’t doing so recklessly, and that has boosted their appeal as Europe’s strains and a weakening global economy increase volatility in financial markets, according to Eric Takaha, a director of corporate and high-yield debt for Franklin Templeton’s fixed-income group that manages more than $350 billion.

“They’ve taken advantage of the strong demand, but I think the fact is that they haven’t really been as aggressive with their balance sheets as they could have been given the amount of money flowing into the asset class,” he said in a telephone interview from San Mateo, California.

Funding Risks

While high-yield liquidity is healthy, borrowers rated B3 or less may find it difficult to refinance their debt because access to credit markets has diminished for lower quality companies, Moody’s analysts led by Kevin Cassidy wrote in a report. The 25 largest companies with “high credit risk” as defined by Moody’s hold $74 billion of junk debt maturing between 2012 and 2016, according to the report.

“The lower a company’s credit rating, the more difficult it will likely be for it to refinance at manageable rates,” the analysts wrote.

Companies including Clear Channel Communications Inc., Texas Competitive Electric Holdings Co. and Caesars Entertainment Corp. may need to restructure, particularly if businesses don’t improve. European sovereign debt concerns and a slowing U.S. economy could further impede access to funding, according to Moody’s.

“There will always be some issuers that would face difficulty refinancing near-term maturities,” Puchalla of Moody’s said. The “bigger picture is that companies on balance have been able to proactively address their maturities. So at least for the next 12 to 15 months, they don’t seem to be a widespread problem.”

To contact the reporter on this story: Brooke Sutherland in New York at bsutherland7@bloomberg.net

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

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