Airline Bonds Rally as Continental, UAL Merge: Credit Markets

May 4 (Bloomberg) -- Airline bond yields are the lowest relative to the rest of the junk-bond market in more than two years as investors step up bets a rebound in air traffic will make it easier for carriers to repay debt.

The extra yield investors demand to own airline bonds instead of Treasuries fell to 6.04 percentage points as of April 30, according to Bank of America Merrill Lynch index data. That’s 0.43 percentage point wider than junk bonds on average, the tightest the spread has been since March 2008.

Carriers are being helped as the return of business travelers and a rise in average ticket prices offsets a 64 percent jump in the average spot-market price for jet fuel from a year earlier. United Airlines parent UAL Corp., which agreed on May 2 to merge with Continental Airlines Inc., was put on review for a possible upgrade from Caa1 by Moody’s Investors Service and its B- rating was placed on CreditWatch with “positive” implications by Standard & Poor’s.

“People view airline debt as less risky as the economy improves,” said Jeff Straebler, a fixed-income strategist at RBS Securities Inc. in Stamford, Connecticut. “With the economy slowly improving, and most people feel that it’s going to stay that way, really the big concern is simply oil.”

Airline bonds have returned 9.35 percent this year through April 30, 2.19 percentage points more than high-yield bonds overall, Bank of America Merrill Lynch index data show. Spreads have narrowed 229 basis points, or 2.29 percentage points, compared with a tightening of 78 basis points to 561 for all speculative-grade credit.

Fed Survey

Elsewhere in credit markets, the extra yield investors demand to own company debt instead of Treasuries was unchanged at 149 basis points, down from 176 at the end of 2009, Bank of America Merrill Lynch’s Global Broad Market Corporate Index shows. Average yields rose 3.3 basis points to 3.958 percent.

The smallest proportion of banks in two years restricted standards on business lending in the first quarter, signaling a possible thaw in credit, according to a Federal Reserve survey of senior loan officers released yesterday. More banks expressed a greater willingness to make installment loans to consumers than in the previous quarterly survey.

“This is just one more feather in the cap of the recovery in the financial markets,” said Michael Darda, chief economist at MKM Partners LLC in Greenwich, Connecticut. “We’re going in the right direction.”

Loan Standards

The shortage of credit, as banks tightened loan standards and many consumers and businesses paid off debt, has impeded the recovery. The central bank cited “tight credit” among the reasons for its April 28 decision to keep interest rates at zero to 0.25 percent for an “extended period.”

Manufacturing in the U.S. expanded in April at the fastest pace since June 2004, indicating the world’s largest economy accelerated as it entered the second quarter. The Institute for Supply Management’s factory index rose to 60.4, exceeding the median forecast in a Bloomberg News survey of 76 economists, from a March reading of 59.6.

Dave & Buster’s, the closely held operator of restaurant entertainment complexes, is seeking $200 million in loans to finance its leveraged buyout. Oak Hill Capital Partners is buying the Dallas-based company from Wellspring Capital Management LLC for about $570 million, Dave & Buster’s said yesterday in a statement. JPMorgan Chase & Co. and Jefferies Group Inc. committed to provide debt financing for the acquisition, according to the statement.

Hyundai Debt

Hyundai Motor Co. plans to issue $960.8 million of bonds backed by auto loans as soon as May 5, according to a person familiar with the offering, who declined to be identified because terms aren’t public. Hyundai last issued similar debt in September, according to data compiled by Bloomberg.

Top-rated bonds backed by auto loans yield about 0.56 percentage point more than Treasuries, compared with 0.81 percentage point on Jan. 5, according to a Bank of America Merrill Lynch index. The debt was trading at a spread of about 3.16 percentage points a year ago, the data show.

About $21 billion in securities backed by auto loans have been sold in 2010, compared with $13.7 billion during the same period last year, Bloomberg data show.

Americans’ spending rose 0.6 percent in March, the most in five months, the Commerce Department said. Incomes increased 0.3 percent, the first gain this year.

Credit Risk Falls

The cost of protecting against defaults on U.S. corporate bonds fell, with the Markit CDX North America Investment Grade Index declining 1.6 basis point to 90.5 basis points as of 5:46 p.m. in New York, according to Markit Group Ltd. The credit- default swaps index typically falls as investor confidence improves and rises as it deteriorates.

The Markit iTraxx Australia index dropped 3 basis points to 84.5 basis points, according to Westpac Banking Corp. The Markit iTraxx Asia index of 50 investment-grade borrowers outside Japan fell 2 basis points to 100.5, Royal Bank of Scotland Group Plc prices show.

Credit 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, spreads widened 3 basis points to 261 basis points, according to JPMorgan’s EMBI+ index, even as the European Central Bank joined international efforts to help Greece avoid a default. The ECB said it would indefinitely accept Greece’s debt as collateral regardless of the credit rating.

Yields on Brazil’s interest-rate futures contracts jumped to the highest level in 14 months as faster-than-forecast inflation boosted speculation benchmark rates will rise. The yield on the contract due January 2011, the most active in Sao Paulo trading, climbed 8 basis points to 11.2 percent at 4:03 p.m. New York time, its highest level since Feb. 25, 2009.

UAL, based in Chicago, and Continental, which has its headquarters in Houston, agreed to merge in a stock swap valued at more than $3 billion to create the world’s largest airline, reviving a deal that fell apart two years ago.

“Consolidation is a positive,” Straebler said in a telephone interview. “If you have fewer large players, they are less likely to try and expand market share at the cost of profitability.”

United’s yield, or average fare per mile, climbed 12 percent in the first quarter in the company’s main jet business. Revenue for each seat flown per mile, a measure of demand and ticket prices, jumped 19 percent while costs on the same basis rose 8.3 percent.

Airline Junk Bonds

Airlines issued $2.66 billion of high-yield notes last year, compared with no sales in 2008 and more than four times the amount of offerings in 2007, Bloomberg data show. United, the only airline to offer dollar-denominated junk bonds in 2010, sold $700 million of notes on Jan. 11, the data show.

The carrier’s $500 million of 9.875 percent senior secured debt due in August 2013 has risen about 6.7 cents from issue to 106 cents on the dollar, according to RW Pressprich & Co. United’s 12 percent secured notes have jumped 12.7 cents to 108.

“Airlines look to be in good financial shape for 2010,” analysts at independent debt research firm CreditSights Inc. wrote in an April 20 report. Carriers’ “access to capital markets should allow financing of 2010 aircraft,” capital expenditures and for refinancing of secured debt maturities, they wrote.

Air carrier “credit quality has improved, but not to the same degree as spreads have tightened,” said Jonathan Root, an analyst at Moody’s in New York. “The investors have comfort with the higher risk because they have the airplanes as security.”

Of the $3.36 billion of airline debt issued since the start of 2009, 91.1 percent has been secured by collateral, Bloomberg data show.