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Europe’s Junk Proves Safer Than Risky Bank Debt: Credit Markets

Investors are judging junk bonds sold by companies in Europe to be safer than banks’ riskiest debt for the first time on concern lenders will lose money amid the region’s sovereign deficit crisis.

The extra yield buyers demand to own high-yield non-financial notes instead of government securities fell below that on bank subordinated debt on Jan. 6, and is now 29 basis points lower, according to Bank of America Merrill Lynch index data. Before November, speculative-grade bond spreads had never been within 100 basis points of those on bank notes, which on average are rated eight steps higher.

The Basel Committee on Banking Supervision announced rules on Jan. 13 that would make banks’ subordinated bonds more likely to absorb losses, aiming to protect taxpayers and help lenders avoid collapse. The lowest-rated non-financial companies are proving more immune to concern stemming from euro-region nations’ mounting debt that has roiled global markets for a year.

“High-yield is a great story,” said Lucette Yvernault, a money manager at Schroders Investment Management Ltd. in London, which oversees 181.5 billion pounds ($288 billion). “Banks are still disturbed by the sovereign uneasiness on one hand and the lack of regulatory support on the other.”

Relative Yields

Relative yields on speculative-grade European company debt shrank 51 basis points to a three-year low of 437 since Oct. 31, a month before Ireland asked for an 85 billion-euro bailout, according to Bank of America Merrill Lynch’s Euro Non-Financial High-Yield Constrained Index. Subordinated bank bond spreads widened 125 basis points in the same period to 466, approaching the highest since July, the EMU Financial Corporate Index, Sub-Type shows.

Debt in Bank of America Merrill Lynch’s corporate junk bond index has an average rating of B1 from Moody’s Investors Service, lower than the A2 investment grade for banks.

Elsewhere in credit markets, the cost of insuring debt sold by Europe’s so-called peripheral nations rose, snapping four days of declines.

Credit-default swaps tied to Spain’s bonds climbed 10 basis points to 304.5, compared with a record-high 364 reached on Nov. 30, according to CMA. The nation is planning to sell 10-year bonds via a group of banks after canceling two debt auctions that were scheduled for Jan. 20, said a finance ministry official who declined to be identified.

Portugal Swaps

Default swaps on Portugal rose 20 basis points to 489, Greece increased 15 basis points to 926 and Italy climbed 8 basis points to 212, CMA prices show. Swaps protecting Ireland’s bonds were 15 basis points higher at 636.

Credit-default swaps typically fall as investor confidence improves and rise as it deteriorates. Contracts pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt, and a basis point equals $1,000 annually on a contract protecting $10 million of debt.

Yields on company debt from the U.S. to Europe and Asia narrowed 1 basis point relative to government bonds last week to 166 basis points, or 1.66 percentage point, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. Spreads, which have tightened 3 basis points this month, are down from 177 on Nov. 30.

Yields jumped to an average 3.93 percent from 3.89 percent. The Barclays Capital Global Aggregate Corporate Index of bonds lost 0.3 percent this month.

Bond Sales Jump

Corporate bond sales worldwide jumped to $108.6 billion for the week, from $82.5 billion the week before, according to data compiled by Bloomberg. New York-based JPMorgan Chase & Co.’s $3.25 billion offering included $1.25 billion of 2.05 percent notes that yield 110 basis points more than similar-maturity Treasuries. The second-biggest U.S. bank by assets paid a spread of 100 basis points on its $550 million of 1.65 percent, three-year debt sold on Sept. 27, Bloomberg data show.

The Standard & Poor’s/LSTA US Leveraged Loan 100 Index rose 1.54 cent for the week to 95.22 cents on the dollar, the highest since Nov. 19, 2007. The index, which tracks the 100 largest dollar-denominated first-lien leveraged loans, has gained 1.59 percent this month. Speculative-grade debt is rated less than Baa3 by Moody’s and BBB- by Standard & Poor’s.

Relative yields in emerging markets fell for a second week, shrinking 4 basis points to 235, according to JPMorgan index data. Over the past three months the index ranged from a high of 279 on Nov. 30 to as low as 217 on Jan. 5.

Bank Losses

Regulators and lawmakers in Europe announced measures this year aimed at preventing another credit crisis that may increase the risk of bank losses. Lenders in the region have already lost or written down $585.8 billion since 2007, according to Bloomberg data.

The Basel committee decided in 2010 to restrict the securities that banks could count toward the capital they’re required to hold as a buffer against losses. Last week the regulators said some subordinated bonds should include triggers forcing lenders to convert them into stock or write them off to avert collapse. That followed a European Union proposal on Jan. 11 that senior bank note holders should share the burden of future government bailouts.

Concern losses will mount is causing European bank credit quality to deteriorate while ratings on speculative-grade corporate borrowers are rising at the fastest pace in at least a decade. S&P lifted the ratings of 56 junk European companies last year while cutting 47, Bloomberg data show. The New York-based ratings firm upgraded 30 financial companies and cut 92.

‘Significantly Decoupled’

Financial credit has “significantly decoupled” from the rest of the corporate bond market since November because of higher expected losses and increased volatility amid the sovereign crisis, Morgan Stanley strategists led by Andrew Sheets said in a Jan. 14 report.

Investor demand for European speculative-grade company debt may cause spreads to tighten to 400 basis points this year, JPMorgan strategists led by Stephen Dulake in London wrote in a Jan. 7 report. Issuance may rise to a record 50 billion euros, surpassing last year’s all-time high of 46.7 billion euros, the strategists wrote.

“Investors will continue to chase yield, and high-yield bonds are the only asset class offering that,” said Alexandre Caminade, who manages the equivalent of about $800 million at Allianz Global Investors Investments Europe. “We’re much less confident about financials than we are about non-financials. It’s very difficult to understand the risks attached.”

Sharing the Pain

European junk bonds may also suffer from the problems faced by banks because they’ll raise funding costs for speculative-grade borrowers, according to Goldman Sachs Group Inc. Government budget constraints will add to the pain felt by junk-rated companies by diminishing public support, Goldman strategists led by Charles Himmelberg and Alberto Gallo wrote in a Jan. 14 report.

“The reliance on bank lending, coupled with persistent bank spread volatility, could eventually spill over in higher funding costs for European borrowers, penalizing highly levered, low-rated firms,” they said in the report. “This is particularly true for the peripheral countries; the same ones where companies rely the most on bank funding.”

Governments and banks in Europe need to refinance about 1 trillion euros of debt in the first half of this year, according to BNP Paribas SA. In the corporate sector, by contrast, many of “the high-yield names that needed to refinance have done so,” said Caminade.

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