Europe Junk Bonds Shrug Off Greece to Beat U.S.: Credit Markets

Feb. 15 (Bloomberg) -- High-yield, high-risk corporate bonds in Europe are beating their U.S. counterparts in a sign investors expect Greece’s deficit crisis will be contained.

Junk bonds in Europe including hybrid securities issued by ABN Amro Bank NV and Spain’s Banco de Valencia SA have returned 2.26 percent this year, compared with a loss of 0.36 percent in the U.S., according to Bank of America Merrill Lynch index data. Even after the gains the securities still yield more than what investors can get in the U.S., offering a cushion against a slowing economy.

European lenders pledged support for Greece last week while it grapples with Europe’s biggest budget deficit as a percentage of gross domestic product, with German Chancellor Angela Merkel and her counterparts offering “determined and coordinated action.” London-based Barclays Capital, the most accurate forecaster in a 2009 Bloomberg News survey, said Feb. 12 that “spillover” to larger countries is unlikely.

“Greece is seen as more of a concern for the banks and investment-grade than for high yield,” said Martin Fridson, chief executive officer of New York-based money-management firm Fridson Investment Advisors. Fridson, who began his career as a corporate bond trader in 1976 and specializes in speculative- grade debt, said the gains are being bolstered by a “big influx” of money from countries including the U.S.

Yield Premiums

Elsewhere in credit markets, the extra yield investors demand to own company bonds instead of government debt widened 2 basis points last week to 171 basis points, while overall yields rose to 4.13 percent from 4.05 percent a day earlier, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index.

Sales of corporate bonds totaled $28.1 billion last week, or 54 percent below the average over the previous 52 weeks, according to data compiled by Bloomberg.

Globally, the number of “weakest links,” or borrowers rated B- and below with a “negative” outlook totaled 213 last week, unchanged from January and down from 265 a year ago, according to Standard & Poor’s. Their combined debt totals $197.5 billion. High-yield bonds are ranked below Baa3 by Moody’s Investors Service and BBB- by S&P.

No companies in Europe have defaulted this year, compared with 12 in the U.S., S&P said. BlackRock Inc., the world’s biggest asset manager, boosted its holdings of Greek bonds as it bets the European Union won’t allow the nation to default.

‘Too Much’ Worry

“They won’t allow a Lehman-type crisis,” said Michael Krautzberger, co-head of European fixed-income who helps oversee BlackRock’s $3.35 trillion of assets from London. “The market has worried too much about an imminent government default in Europe that will not happen because of the solidarity.”

European leaders are working on measures such as establishing a lending facility for Greece, with each country making a contribution according to its size, an EU official said last week on condition of anonymity. They stopped short of providing taxpayers’ money or diluting their demands for the country to cut its budget shortfall.

Greece, representing 2.7 percent of the euro region’s $13 trillion economy, posted a budget deficit of 12.7 percent of GDP in 2009, the highest in the euro’s 11-year history and more than four times the EU’s 3 percent limit.

The nation’s “fiscal situation is serious,” but it’s “not the final death knell” for Europe and “spillover to bigger countries such as Spain and Italy is preventable,” Barclays analysts including Julian Callow in London wrote in a research note Feb. 12.

U.K. Leads

Junk bonds issued by borrowers in the U.K., Europe’s second-largest economy, are leading the gains. They returned 3.6 percent, while debt sold by Spanish companies handed investors 1.13 percent, Merrill Lynch data show. Even high-yield notes issued by Greek companies rallied 2.08 percent this year.

Credit derivatives show the junk bonds may be poised to fall after the cost to protect the securities from default rose to a two-month high on Feb. 12.

The Markit iTraxx Crossover Index of credit-default swaps on 50 European companies climbed 19 basis points on Feb. 12 to 495, according to JPMorgan Chase & Co. The cost of protecting bank bonds from default also rose, as the Markit iTraxx Financial Index of 25 banks and insurers jumped 6 basis points to 103, or 1.03 percentage points.

Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A basis point on a contract protecting 10 million euros ($13.6 million) of debt from default for five years equals to 1,000 euros a year.

Bond Default

Defaults in Europe have been below expectations, according to Moody’s. The 12-month default rate fell to 9.6 percent in January from 10.3 percent the previous month, Moody’s said in a report Feb. 9. A year ago, the New York-based ratings company was predicting European defaults would peak at 19.6 percent in the final quarter of 2009.

Junk bonds and credit-default swaps are diverging because “99 percent of people you speak to don’t believe Greece is going to default, but people are still buying protection,” said Neil Murray, who oversees about 25 billion pounds ($39 billion) of corporate bonds as head of credit at Scottish Widows Investment Partnership in Edinburgh.

Investors demand an average 9.64 percent to own junk bonds in Europe, compared with 9.44 percent in the U.S., the smallest gap since January 2008, Merrill Lynch indexes show. The difference has shrunk from 1.27 percentage points at the end of 2009 and 8 percentage points in May.

Bond Bargains

“We still think you can buy reasonably good names at, say, 9 percent,” said Andrew Sutherland, who oversees 23 billion pounds of company bonds as head of credit at Standard Life Investments in Edinburgh.

European junk bonds in Europe rallied 77 percent in 2009, compared with 58 percent in the U.S., as credit and equity markets worldwide recovered from the worst financial and economic crisis since the 1930s.

The relative lack of new junk bonds issued in Europe also contributed to the outperformance, Fridson said. Companies have sold 5.58 billion euros of the debt in Europe this year, compared with a record $26.5 billion in the U.S., according to data compiled by Bloomberg.

This week, Vestas Wind Systems A/S, an unrated, Copenhagen- based company which is the world’s biggest maker of wind turbines, may sell bonds for the first time after meeting with fixed-income investors last week. Italian utility Acea SpA, which is rated A, or five levels above junk by S&P, hired banks to sell as much as 500 million euros of 10-year bonds, a banker involved in the deal said.