Lenders to speculative-grade companies in Europe are charging the lowest interest rates since before credit markets seized up, in a sign they don’t expect the region’s fiscal crisis to infect the corporate debt market.
Investors demand an average yield of 7.62 percentage points to hold junk-rated European debt, the lowest since July 2007, according to Bank of America Merrill Lynch index data. Yields on bonds sold by Continental AG, Europe’s second-largest auto parts supplier, and German drugmaker Phoenix Pharmahandel GmbH & Co KG have fallen more than 2 percentage points in the past three months.
While nations from Greece to Ireland struggle with budget deficits above the European Union limit, companies are taking advantage of a global rally in corporate debt to refinance and extend maturities. The default rate in the region fell to 3.5 percent at the end of September from 5.6 percent three months earlier, and is forecast to drop to 2.2 percent by year-end, Moody’s Investors Service said in an Oct. 7 report.
“High-yield companies have restructured their balance sheets,” and “the outlook is positive for them to service their debt,” said Louis Gargour, chief investment officer in London at LNG Capital LLP, which is raising $100 million for a new European high-yield credit fund. “Whereas governments have done the opposite.”
European corporate junk bonds have returned 16 percent this year, including reinvested interest, Bank of America Merrill Lynch data show, helping sales almost double and borrowers to avoid default. Euro-region government notes returned little more than half that as fundraising programs to plug spiraling budget deficits and bail out banking systems in so-called peripheral countries weighed on sovereign credit.
Companies in Europe issued 57 billion euros ($79.5 billion) of junk-rated bonds this year, almost double the amount raised in the same period in 2009, according to data compiled by Bloomberg. High-yield, or junk, bonds are rated below Baa3 by Moody’s and BBB- by Standard & Poor’s.
Elsewhere in credit markets, the extra yield investors demand to hold global corporate bonds rather than government debentures fell last week to the least in almost five months. In the U.S., a benchmark measure of corporate credit risk declined by the most since July. Price on leveraged loans rallied for a sixth week.
Spreads on company bonds from the U.S. to Europe and Asia ended the week at 169 basis points, or 1.69 percentage points, according to Bank of America Merrill Lynch’s Global Broad Market Corporate index. That’s the narrowest since May 13 and down 12 basis points since August. The gap has ranged from a low this year of 142 in April to a high of 201 in June. Average yields fell to 3.37 percent from 3.48 percent on Oct. 1.
In the global new issue market, Auckland-based Reynolds Group Holdings Ltd.’s $3 billion offering, the second-biggest of U.S. junk debt deal this year, led $57.2 billion of corporate bond sales worldwide last week. That compares with $72.2 billion in the period ended Oct. 1.
The packaging company’s $1.5 billion of 9 percent notes due in April 2019, issued at par on Oct. 6, rose 2.5 cents to 102.5 cents on the dollar, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Credit-default swaps on the Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or speculate on creditworthiness, fell 7.7 basis points last week to 96.5 basis points, according to prices from Markit Group Ltd. That’s the biggest drop since the week ended July 9, when the index fell 12 basis points.
In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings dropped 7 for the week to 101.75, Markit Group prices show.
The indexes typically fall as investor confidence improves and rise as it deteriorates. Credit-default 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.
In emerging markets, relative yields shrank 2 basis points for the week to 269 basis points, the lowest since Aug. 23, JPMorgan Chase & Co. index data show.
The Standard & Poor’s/LSTA US Leveraged Loan 100 Index climbed 0.32 cent for the week to 90.78 cents on the dollar, the highest since May 17. The index, which tracks the 100 largest dollar-denominated first-lien leveraged loans, returned 6.6 percent this year.
Europe Junk Yields
Yields on European junk bonds have fallen faster than those in the U.S. The average rate dropped from as high as 10.35 percent in June, according to Bank of America Merrill Lynch’s EMU Corporate Index, while for U.S. bonds, yields fell to 7.87 percent from 9.49 percent.
European bonds have also returned more than their U.S. counterparts, which gained 13 percent in 2010, according to Bank of America Merrill Lynch’s U.S. High-Yield Master II Index. Globally, the securities have rallied 14 percent, compared with 60.6 percent for all of 2009. The returns compare with 7 percent for investment-grade bonds in euros and 6.6 percent for euro- region government debt, the indexes show.
Phoenix, the drug wholesaler owned by Germany’s Merckle family, sold 506 million euros of four-year notes in July that were priced to yield 894 basis points more than government bonds. The spread has since tightened 333, according to Bank of America Merrill Lynch index data
Continental sold its 750 million euros of 2015 bonds on July 9 at a yield premium of 716 basis points. The spread has shrunk to 236, the data show.
“Investors are still keen for junk bonds,” said Ben Squire, a senior credit analyst in London at Societe Generale SA, France’s second-biggest bank. “Companies’ fundamentals are broadly attractive.”
The EU and International Monetary Fund were forced to bail out the most indebted euro-region members with a $1 trillion loan package in May. The crisis began in the first quarter in Greece and spread to other mostly southern European nations, driving up their borrowing costs.
Spain’s top credit rating was cut one level by Moody’s on Sept. 30, which cited the country’s “weak” economic outlook. Ireland estimated on the same day that the cost of repairing its financial system may rise to as much a 50 billion euros, which would drive its budget deficit to 32 percent of gross domestic product.
Irish 10-year bond yields soared to a record 454 basis points more than German bunds on Sept. 29, according to data compiled by Bloomberg. Portuguese 2020 debt spreads jumped to an all-time high of 441 basis points a day earlier, while Spain’s yields reached a two-month high of 199 against the German benchmark.
Corporate junk bonds, meanwhile, are benefitting from central banks’ low rate policies to help economies recover. The European Central Bank cut its main refinancing rate to an all- time low 1 percent in April 2009 and has kept it there ever since, while the Federal Reserve has maintained its target rate for overnight loans between banks in a record-low range of zero percent to 0.25 percent since December 2008.
“Bizarrely, the lower down the credit spectrum you are, the better the picture in terms of insulation to sovereign debt concerns” because “such companies would never have been bailed out by a government,” said Mahesh Bhimalingam, head of European fundamental credit strategy in London at Deutsche Bank AG, Germany’s biggest lender. “High-yield companies have actually benefitted in terms of demand from the sovereign debt crisis as they are insulated from their countries’ deficits.”
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