Corporate Bonds Extend Longest Streak Since ’04: Credit Markets

March 31 (Bloomberg) -- Corporate bonds are rallying for the fourth straight quarter, the longest streak since 2004, extending a record advance as 72 percent of companies beat analysts’ earnings expectations.

The securities returned 2.6 percent this quarter through March 30, following a 16.3 percent gain in 2009, according to a Bank of America Merrill Lynch index. The extra yield, or spread, investors demand to own corporate bonds fell 0.26 percentage point since year-end relative to benchmarks to 1.5 percentage points as of yesterday, the narrowest since November 2007.

Company debt rallied on signs the global economy is improving, with U.S. consumer confidence gaining in March and corporate defaults declining from record levels. Borrowing costs declined to the lowest since 2005, spurring $730 billion of bond issuance globally this quarter, a 25 percent increase from the final period of last year.

“We’ve certainly had a very good ride over the last 12 to 15 months, but there still is good value in corporate bonds today in select areas such as banking,” Mark Kiesel, global head of corporate bond portfolio management at Pacific Investment Management Co. in Newport Beach, California, said in a Bloomberg Television interview.

Debt ranging from leveraged loans to high-yield bonds to commercial mortgage-backed securities climbed in the quarter as the Federal Reserve’s zero-interest-rate policy prompted investors to seek riskier assets.

“Investors initially were only concerned about protecting their principal,” said Matt Freund, a money manager for fixed- income investments at San Antonio-based USAA Investment Management Co., who helps oversee $44 billion of assets. “Now that they’ve been reassured, they want spread product.”

Citigroup Prices CLO

Elsewhere in credit markets, the aircraft-leasing unit of American International Group Inc. sold $750 million of notes in a two-part reopening. Citigroup Inc. priced a $525 million collateralized loan obligation, the first new issue backed by widely syndicated debt in the CLO market since last March. Lyondell Chemical Co.’s $500 million term loan to help finance its exit from bankruptcy rose during initial trading.

International Lease Finance Corp., the Los Angeles-based AIG unit, sold $500 million of 8.75 percent notes due in 2017 and $250 million of 8.625 percent debt maturing in 2015, according to data compiled by Bloomberg.

The Citigroup deal, managed by WCAS Fraser Sullivan Investment Management LLC, was boosted from a planned $500 million, said a person familiar with the transaction who declined to be identified because terms aren’t public. The CLO refinances an existing fund, COA CLO Financing Ltd., and increases its size by more than 50 percent.

Lyondell Loans

Houston-based Lyondell’s loan, sold at a discount of 99 cents on the dollar, climbed as high as 100.75 cents, according to people familiar with the trades who declined to be identified because the transactions are private. It initially broke at 100.25 cents, the people said.

UBS AG arranged the term loan due in 2016 with an interest rate 4 percentage points more than the London interbank offered rate, with a 1.5 percent Libor floor, the people said. Three- month Libor, the rate banks charge to lend to each other, is 0.29 percent.

The cost to protect against defaults on corporate bonds in the U.S. rose for the first time in four days.

The Markit CDX North America Investment Grade Index Series 14, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, increased 1.1 basis point to a mid-price of 86.3 basis points as of 5:18 p.m. in New York, according to Markit Group Ltd. The index typically increases as investor confidence deteriorates.

European iTraxx

In London, the Markit iTraxx Europe Index on 125 investment-grade companies was unchanged at 77.5 basis points, according to JPMorgan Chase & Co.

Greece led an increase in the cost of credit-default swaps on sovereign debt after the country’s new seven-year bond offering fell in trading, deepening concern that Europe’s most indebted nations may struggle to fund their budget deficits.

Contracts on Greek government debt rose 20 basis points to 335.5 in London, the highest in more than a week, according to CMA DataVision. Swaps on Spain, Portugal, Italy and Ireland also climbed and the Markit iTraxx SovX Western Europe Index of contracts on 15 governments rose 3.5 basis points to 82, the highest level in a month.

Bondholder Protection

The Markit iTraxx Australia index rose 2 basis points to 85.5 basis points, according to Citigroup, while the Markit iTraxx Japan index increased 0.5 basis point to 114 in Tokyo, Morgan Stanley prices show.

The Markit iTraxx Asia index of 50 investment-grade borrowers outside Japan increased 1.5 basis point to 96.5, according to Royal Bank of Scotland Group Plc prices.

Credit swaps pay the buyer face value if a borrower defaults in exchange for the underlying securities or the cash equivalent. A basis point is 0.01 percentage point and equals $1,000 annually on a contract protecting $10 million of debt for five years. Worldwide corporate bond sales for the first three months compare with $583 billion in the fourth quarter of 2009 and $1 trillion in the same period last year, Bloomberg data show.

Warren Buffett’s Berkshire Hathaway Inc. and Kraft Foods Inc. the maker of Oreos that’s buying Cadbury Plc, led the busiest day of the quarter in the U.S., as issuance reached $18.85 billion on Feb. 4.

Junk Bonds

Junk bond sales reached a record $38.9 billion in March, passing the previous high of $36 billion in November 2006, Bloomberg data show. Speculative-grade securities are rated below Baa3 by Moody’s Investors Service and lower than BBB- by Standard & Poor’s. The debt returned 5.61 percent through March 30, after gaining 60.6 percent last year, according to the Bank of America Merrill Lynch Global High Yield Index.

The bonds rallied as the percentage of speculative-grade companies defaulting in the prior 12 months fell to 11.6 percent in February, from a peak of 12.9 percent in November, Moody’s said March 4. The rate will fall to 2.9 percent by the end of this year, Moody’s said.

The S&P/LSTA US Leveraged Loan 100 Index gained 4.16 percent this year as companies sold junk bonds to repay their bank loans. That extended the record 52.2 percent gain in 2009.

Commercial mortgage-backed securities advanced 7.1 percent this quarter, according to a Bank of America Merrill Lynch CMBS index, after returning 27.9 percent in 2009.

Earnings Surprises

Bond returns are justified by corporate earnings, USAA’s Freund said. Companies in the S&P 500 Index beat analyst estimates 72 percent of the time in the quarter, the second- highest percentage for positive earnings surprises on record, Bloomberg data show.

Consumers in the U.S. gained confidence in March as the gloom over job prospects began to lift, indicating employment will be central to preserving the recent acceleration in spending.

The Conference Board’s confidence index rose to 52.5, exceeding the median forecast of economists surveyed by Bloomberg News, from 46.4 in February, according to figures from the New York research group.

“With signs of improvement in the labor market, confidence is more likely to be up than down in the next few months,” said James O’Sullivan, chief economist at MF Global Ltd. in New York, who forecast sentiment would pick up. “It’s still a low level of confidence.”

Rally Waning?

The rally in credit may be waning as expectations grow that the Fed will raise interest rates, undermining returns in fixed- income markets and prompting investors to shift money into equity funds, Bank of America Corp. strategists said in a March 26 note to investors.

“Such a shift in liquidity may well persist as yield levels in fixed income no longer provide for the equity-like return potential that debt once offered,” strategists led by Jeffrey Rosenberg in New York wrote in the report. That would leave “a less robust liquidity environment for debt.”

Corporate bonds offer opportunities for additional gains, even as economic growth may be hampered by governments withdrawing stimulus programs, Pimco’s Kiesel said. He recommends investors buy financial and emerging-market debt.

“You can still get 5 to 6 percent returns, which still look very attractive relative to other fixed income alternatives,” Kiesel said.