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Bond Distress at Three-Year Low on U.S. Refinancings


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 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, global corporate bond sales totaled $79.4 billion last week, led by a record $49.7 billion in the U.S., according to data compiled by Bloomberg. The surge in sales wasn’t enough to keep relative yields from shrinking by the most since the period ended Dec. 10. Prices of leveraged, or speculative-grade, loans rose to the highest in two years and spreads on emerging-market debt shrank.

General Electric Co.’s finance unit sold $6 billion of notes in the largest offering in 11 months, Bloomberg data show, as a private report showed service industries expanded at the fastest pace since May 2006.

Economic Recovery

“We’ve had a lot of good news come up economically, at least within the U.S., so that’s put some wind behind the sails,” said Thomas Chow, who helps oversee $120 billion of fixed-income assets at Philadelphia-based Delaware Investments.

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.

The S&P/LSTA U.S. Leveraged Loan 100 Index rose 0.78 cent to 93.69 cents on the dollar, the biggest weekly increase since April 2. The index reached its highest level since January 2008 last week.

In emerging markets, relative yields narrowed 5 basis points to 239 basis points, according to JPMorgan index data. Spreads, which have contracted from last year’s high of 359 in May, have fluctuated between 217 and 279 the past three months.

U.S. Growth

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.

“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.

Defaults Decline

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.

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.

Company Profits

“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 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.