Libor Shows Strain, Sales Dwindle, Spreads Soar: Credit Markets
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By John Glover and Caroline Hyde
May 24 (Bloomberg) — Corporate bond sales are poised for their worst month in a decade, while relative yields are rising at the fastest pace since Lehman Brothers Holdings Inc.’s collapse as the response by lawmakers to Europe’s sovereign debt crisis fails to inspire investor confidence.
Companies have issued $47 billion of debt in May, down from $183 billion in April and the least since December 1999, data compiled by Bloomberg show. The extra yield investors demand to hold company debt rather than benchmark government securities is headed for the biggest monthly gain since October 2008, Bank of America Merrill Lynch’s Global Broad Market index shows.
Concern that European leaders won’t be able to coordinate a response to rising levels of government debt from Greece to Spain, while U.S. legislation threatens to curb credit and hurt bank profits, is driving investors away from all but the safest securities. The rate banks say they charge each other for three- month loans in dollars has almost doubled since February.
“This is a quintessential liquidity crisis,” said William Cunningham, head of credit strategies and fixed-income research at Boston-based State Street Corp.’s investment unit, which oversees almost $2 trillion. “It’s not inconceivable to imagine a situation where the markets behave so poorly, the liquidity behaves so badly, and risk-tolerance just evaporates that — particularly in Europe — consumers contract, businesses stop hiring and stop investing, and economic activity halts.”
Spreads, Junk Bonds
Yields on corporate bonds average 188 basis points more than government debt, up from 149 at the end of April and the low this year of 142 on April 21, Bank of America Merrill Lynch’s index shows. The last time spreads widened as fast was October 2008, when they soared 108 basis points, or 1.08 percentage point, to 467.
Junk bonds issued in the U.S. have been especially hard hit, with spreads expanding 141 basis points this month to 702, contributing to a loss of 3.78 percent. Leveraged loans, or those rated speculative grade, have also tumbled. The S&P/LSTA U.S. Leveraged Loan 100 Index ended last week at 89.23 cents on the dollar, from 92.90 cents on April 26.
The market turmoil has made banks reluctant to lend to each other. The London interbank offered rate, or Libor, for three- month loans in dollars reached 0.497 percent on May 21, the highest since July 24.
Libor has been climbing as concern grows about the quality of banks’ collateral amid the euro-region’s financial crisis. Citigroup Global Markets Inc. strategist Neela Gollapudi in New York said in a report that the rate has the potential to reach 1 percent to 1.5 percent “over the next several months” after the U.S. Senate approved a financial-regulation overhaul that may increase banks’ uncertainty about how they will be able to fund themselves.
“We’re seeing risk aversion intensifying, as well as a widening of risk aversion across asset classes,” said Peter Chatwell, an interest-rate strategist at Credit Agricole Corporate and Investment Bank in London. “That raises concern over counterparty risk and is pushing rates higher in the interbank market.”
Traders in the forward market are betting the premium of the three-month dollar London interbank offered rate, or Libor, over what investors expect the overnight federal funds rate to average — known as the Libor-OIS spread — will climb to about 42 basis points next month and about 61 basis points by September, according to UBS AG data. The spot spread was about 27 basis points May 21.
The spread, a gauge of banks’ reluctance to lend, surged to a record 364 basis points on Oct. 10, 2008, as Lehman’s collapse almost triggered a freeze in interbank lending. Overnight index swaps, or OIS, shows where traders expect the Federal Reserve’s overnight effective rate will average for the term of the swap.
Turmoil in financial markets was exacerbated last week when German Chancellor Angela Merkel stepped up calls for regulation and forbade some types of short-selling without consulting with her European partners. In a short-sale, an investor bets on the decline in a security’s price. Nations including France and the Netherlands said they didn’t plan to follow Germany’s lead.
“Policy makers have different views and priorities in different countries, said Jamie Stuttard, head of European and U.K. fixed income at Schroder Investment Management in London. “Almost inevitably, they aren’t speaking with one voice.”
Signs of Weakness
The latest concerns about the fiscal health of nation, and of the banks that hold their bonds are surfacing as the economic backdrop shows signs of worsening.
More Americans unexpectedly filed applications for unemployment benefits last week, as Labor Department figures showed initial jobless claims rose by 25,000 to 471,000, the highest level for a month and exceeding the median forecast of economists surveyed by Bloomberg. An index of U.S. leading indicators fell 0.1 percent in April, a sign the economic expansion may slow in the second half of the year, Conference Board data showed on May 20.
The ZEW Center for European Economic Research in Mannheim, Germany said last week its index of investor and analyst expectations in Europe’s largest economy fell the most since Lehman collapsed. The euro is swinging between gains and losses after weakening to a four-year low against the dollar last week. The currency shared by the 16 members of the euro region traded at $1.2570 last week.
“De-risking by investors and regulatory uncertainty are combining to create deteriorating liquidity in fixed-income markets,” debt strategists at New York-based JPMorgan Chase & Co. said in a report dated May 21. “Look for the flight to liquidity to persist, liquidity differentials to widen, and less liquid asset classes to cheapen in the near term.”
Volkswagen AG, Europe’s largest carmaker, postponed a planned 686.3 million-euro sale of securities backed by Spanish car loans on May 10. A spokesman who declined to be identified cited “adverse market conditions.”
Eurasian Natural Resources Corp., a London-based iron ore and alumina miner, delayed a debut dollar-denominated note sale this month because of market volatility, people familiar with the matter said. Towergate Partnership Ltd., Europe’s largest independent insurance broker, postponed a 665 million-pound ($961 million) sale of high-yield bonds on May 13 until markets improve, said people with knowledge of the deal.
Improving Balance Sheets
The last benchmark-sized sales of 500 million euros or more in Europe were by Casino Guichard-Perrachon SA, Europe’s biggest retailer, and Aeroports de Paris SA in April.
“If companies want to come to the market now in size they’d have to pay a higher premium to do so,” said Felix Freund, a Frankfurt-based money manager at Union Investment GmbH, which oversees 160 billion euros of assets. “Companies are generally well funded from last year’s record issuance and from high cash positions on their balance sheets.”
Of the companies covered by Morgan Stanley’s credit strategists, 70 percent reduced their leverage ratios in the first quarter, up from about 50 percent two quarters earlier, according to a report published by the firm on May 21. For investment-grade companies, cash remains at “multi-year’ highs of 23 percent relative to debt, and 15 percent for speculative- grade borrowers, the firm said.
“Given the backup in spreads over the past month, as well as the deleveraging we expect this year, risk-adjusted valuations have gone from roughly fair to once again cheap,” Morgan Stanley strategists Rizwan Hussain and Adam Richmond wrote in the report.
Even so, the cost to protect against losses on corporate bonds with credit-default swaps remains elevated.
The Markit CDX North America Investment Grade Index Series 14 rose May 20 to near its 10-month high of 127.79 basis points on May 6, before slipping back to 119.25 basis points as of 5:51 p.m. in New York on May 21. The index typically rises as investor confidence drops.
In Europe, the Markit iTraxx Crossover Index of 50 mostly junk-rated companies has climbed 206 basis points this month to 632, the highest level since Aug. 19, according to JPMorgan data. The Markit iTraxx Financial Index of 25 European banks and insurers advanced 58 basis points to 176.
Credit-default swaps tied to the debt of Deutsche Bank AG, Germany’s biggest lender, increased 46 basis points since April 30 to 172, Paris-based Societe Generale SA climbed 40 basis points to 160 and Spain’s Banco Santander SA rose 44 basis points to 191, according to CMA.
Sovereign, Emerging Debt
The cost of protecting against losses on sovereign debt also rose, with the Markit iTraxx SovX Western Europe Index surging 35 basis points to 143. Greece jumped 84 basis points to 726, Portugal climbed 60 basis points to 335 and Spain increased 52.5 basis points to 209.5, CMA prices show.
Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. A basis point on a credit-default swap contract protecting 10 million euros ($12.5 million) of debt from default for five years is equivalent to 1,000 euros a year.
In emerging markets, spreads on bonds widened in four of the past five weeks, ending at 337 basis points on average on May 21, according to JPMorgan prices. That’s up from the low this year of 230 on April 15.
Traders are reducing bets that borrowing costs will rise in Brazil, one of the biggest emerging markets. In the nation’s overnight interest-rate futures market, the yield on contracts due in January fell six basis points, or 0.06 percentage point, on May 21 to 10.93 percent. The yield declined 15 basis points last week, the biggest drop since the five-day period ended March 19.
“This all showed that the authorities haven’t really been co-operating with each other,” said Paul Owens, a credit analyst at Liontrust Investment Services Ltd. in London, which had the equivalent of $1.8 billion under management as of Dec. 30. Widening bond spreads “are a measure of the seriousness of the risks and the wider and more uncertain range of outcomes,” he said.