Tags: Bond | Prognosis | Weakens | raters

Raters Slash Bond Outlooks Amid 'Rehab' Recovery

Monday, 27 September 2010 11:54 AM

Ratings firms are lowering their assessments of future U.S. corporate credit quality more often than they are raising them for the first time since the beginning of 2010 in a trend that may foreshadow losses for bondholders enjoying the biggest quarterly rally in a year.

Moody’s Investors Service cut its outlook on 120 issuers this quarter, while raising if for 40, according to data compiled by Bloomberg. Standard & Poor’s reduced 76 companies and lifted 51. In the three-month period ended in June, positive predictions exceeded cuts at each ratings firm.

The reversal comes as reports show the economic recovery is slowing and signals that the 4.6 percent gain in corporate bonds this quarter, the most since they returned 9.58 percent in the third quarter of 2009, may lose steam. Moody’s downgraded its outlook on retailers to “stable” from “positive” on Sept. 22, saying the industry “exhausted the ability” to boost profit through slashing costs and streamlining inventory.

“We’re not so much in recovery as rehab,” said John Lonski, the chief economist of Moody’s Capital Markets Group in New York. “There are some very large millstones hanging around the neck of the American consumer.”

The extra yield investors demand to hold U.S. corporate bonds rather than government debt has narrowed to 282 basis points, or 2.82 percentage points, from 317 basis points on June 30, according to Bank of America Merrill Lynch’s U.S. Corporate & High Yield Master index. Spreads reached 281 basis points this month, the lowest since May 18.

Relative Yields

After the credit outlook in the first three months of this year signaled deterioration, relative yields widened from 252 basis points on March 31, according to the index.

The outlook on a credit rating indicates the likely direction of a change in the grade and takes into account the economy and conditions specific to the company and its industry.

Elsewhere in credit markets, yield spreads on corporate debt worldwide ended the week higher. Microsoft Corp., the world’s largest software maker, led $124.2 billion of U.S. issuance this month, on pace to beat the high of $125.1 billion in September 2009, Bloomberg data show. Leveraged loan prices rose for a fourth week.

Relative yields on corporate bonds from Asia to Europe and North America widened 1 basis point on average since Sept. 17 to 172 basis points, Bank of America Merrill Lynch’s Global Broad Market Corporate index shows. The world index narrowed from 181 basis points at the end of August and 196 in June. Yields fell to 3.5 percent on average, from 3.57 percent on Sept. 17.

Microsoft Offering

Bonds in the index have returned 3.4 percent since June and 8.6 percent this year. While that trails the 5.7 percent return on Bank of America Merrill Lynch’s Global Sovereign Broad Market Plus index, it’s better than the 3.32 percent gain, including reinvested dividends, for the MSCI World Index of stocks.

Microsoft, based in Redmond, Washington, sold $4.75 billion of bonds on Sept. 22, including three- and five-year debt at the lowest coupons for those maturities on record. Global issuance for the month totals $303.9 billion, compared with $358.4 billion in all of September 2009, Bloomberg data show.

The Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index rose 0.26 cent for the week to 90.21 cents on the dollar. The index, which tracks the 100 largest dollar-denominated first- lien leveraged loans, reached 90.24 cents on Sept. 22, the highest since May 19. Loans have returned 3.74 percent this quarter and 5.34 percent for the year.

Loan Volume

Institutional loan volume totals $90.3 billion this year, compared with $38.3 billion in all of 2009 and $72.4 billion in 2008, according to JPMorgan Chase & Co. Some 10 deals priced last week totaling $6.7 billion, the highest volume since May, the firm said in a report dated Sept. 24.

The Markit CDX North America Investment Grade Index Series 15, a credit-default swaps benchmark that investors use to hedge against losses on corporate debt or to speculate on creditworthiness, fell on Sept. 24 after climbing in its first three days of trading.

The new series of the index fell 5.25 basis points to 108.94 basis points, after rising 7.58 basis points in the three days ended Sept. 23, according to prices from Markit Group Ltd. the measure typically declines as investor confidence improves.

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.

Emerging Markets

In emerging markets, relative yields rose 5 basis points for the week to 280 basis points, according to JPMorgan index data. Spreads narrowed from 299 basis points on Aug. 31 and 338 basis points at the end of June.

S&P has cut 29 companies’ credit outlooks this month while raising eight, Bloomberg data show. In August, the New York- based unit of McGraw-Hill Cos. reduced its forecast on 28 borrowers and boosted 21. That followed 19 cuts and 22 increases in July.

Both Moody’s and S&P raised more outlooks than they cut in the second quarter. Moody’s upgraded 64 issuers while cutting 38, and S&P lifted 91 and slashed 85. In the first quarter, downgrades exceeded upgrades at both firms.

The economic recovery in the U.S. weakened last quarter more than initially estimated, with growth at a 1.6 percent annual pace as consumer spending declined and business investment cooled. Federal Reserve Chairman Ben S. Bernanke and his fellow policy makers indicated Sept. 21 they may have to implement additional measures, such as so-called quantitative easing, to buoy the recovery.

Risk Compensation

Bondholders aren’t being compensated for the risk they’re taking when they invest in the lowest-rated company debt, said James Kochan, chief fixed-income strategist at Wells Fargo Funds Management, which oversees $175.6 billion of debt assets.

Bonds rated CCC or lower have gained 145 percent since March 2009, when spreads on speculative-grade debt rose to 18.9 percentage points, Bank of America Merrill Lynch index data show. Spreads on debt rated below Baa3 by Moody’s and lower than BBB- by S&P have narrowed to 6.32 percentage points.

“The weakest of the high-yield market has rallied so dramatically, and I think it’s appropriate to ask if investors are being adequately compensated for the credit risk they’re taking,” said Kochan, who’s based in Menomonee Falls, Wisconsin. “You have to question some of the valuations now.”

S&P’s outlook is worsening even though the firm upgraded the ratings of more companies than it cut this quarter, Bloomberg data show. S&P has raised 158 ratings and lowered 156 since June 30.

Moody’s forecasts the U.S. speculative-grade default rate will decline to 2.9 percent by December and 2 percent by next August, the firm said in a Sept. 8 report. Ratings companies’ default forecasts are based on data including bond spreads, the economy and historical non-payment rates.

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Ratings firms are lowering their assessments of future U.S. corporate credit quality more often than they are raising them for the first time since the beginning of 2010 in a trend that may foreshadow losses for bondholders enjoying the biggest quarterly rally in a...
Monday, 27 September 2010 11:54 AM
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