A gauge of U.S. corporate credit risk increased as European stocks fell the most in two weeks on concern that leaders will have difficulty resolving the sovereign debt crisis.
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, increased 0.3 basis point to a mid-price of 85.5 basis points at 4:33 p.m. in New York, according to prices compiled by Bloomberg.
The measure widened after the Stoxx Europe 600 Index dropped 0.4 percent, the most since Sept. 4. European Central Bank Governing Council member Luc Coene said yesterday that rising yields may force Spain to ask for assistance. Investors are concerned that a slow resolution to the financial turmoil in Europe will impair global corporate balance sheets.
The credit swaps index, which typically rises as investor confidence deteriorates and falls as it improves, reached an 18- month low of 83 basis points last week after the Federal Reserve’s announcement of a third round of quantitative easing. The contracts 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.
“The government participation in the pricing mechanism has been crazy,” William Larkin, a fixed-income money manager at Cabot Money Management Inc. in Salem, Massachusetts, said in a telephone interview. With the Fed holding interest rates so low, investors are reaching for yield, Larkin said, so “a lot of more obscure companies have access to the capital markets that normally don’t,” which could introduce greater risk.
Contracts protecting against the default of Office Depot Inc. (ODP) bonds fell to 5.5 percent upfront at 1:38 p.m. in New York, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. That’s down from 8.5 percent upfront on Sept. 13, and means investors now pay $550,000 initially and $500,000 annually to protect $10 million of Office Depot’s debt.
The decrease in upfront price comes as activist investor Starboard Value LP increased its stake, becoming Office Depot’s largest shareholder and pushing for changes to improve earnings. Starboard CEO Jeffrey Smith wrote in a letter yesterday that Office Depot should move to smaller stores, reduce the number of items it sells and “significantly” lower advertising costs.
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