Leveraged loans are generating their biggest losses of the year as investors pull back from even the safest debt in a company's capital structure on concern that Europe's financial crisis will spark a global slowdown that diminishes the creditworthiness of borrowers.
Syndicated loans of speculative-grade borrowers lost 1.22 percent last month, the most since November, snapping the longest rally since the eight months ended February 2011, according to the Standard & Poor's/LSTA U.S. Leveraged 100 Loan index. The last time investors lost money in the debt of companies such as Energy Future Holdings Corp. was in November, when the market fell 1.34 percent.
At the same time that Spain seeks a bailout for its banks and speculation increases that Greece will leave the 17-member euro, Federal Reserve data released last week showed corporate profits are climbing at the slowest pace since they dropped in the final quarter of 2008. Growth in commercial and industrial lending is slowing as banks retrench, Fed data also show.
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"The two big things that are driving the market are the European sovereign debt crisis and the economic backdrop," Michael Anderson, a U.S. high-yield strategist at Citigroup Inc. in New York said yesterday in a telephone interview. "We reduced our weighting on high-yield bonds and loans in early May, and our rational for doing that was the macro backdrop. We think there's still more to come."
Retail investors pulled $201.4 million from U.S. floating- rate funds, which buy leveraged loans, during the week ended May 30, according to EPFR Global, a Cambridge, Massachusetts-based research firm. That's the biggest weekly outflow this year and follows $59 million of withdrawals the week before.
The cost of leveraged loans sold to non-bank lenders increased in May to 4.98 percentage points more than lending benchmarks, the widest margin since 5.01 percentage points in January, according to S&P Capital IQ Leveraged Commentary & Data.
Elsewhere in credit markets, Deere & Co. plans to sell 10- and 30-year debt almost two months after the financing arm of the largest maker of agricultural equipment issued $1 billion at its lowest coupons. A gauge of corporate credit risk rose for a fifth day as euro-area services and manufacturing output contracted at the fastest pace in almost three years.
Bonds of Caracas-based Petroleos de Venezuela SA, the state oil company, are the most actively traded dollar-denominated corporate securities today, with 73 trades of $1 million or more as of 11:54 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Deere Bonds
Deere's offering will be of benchmark size, typically at least $500 million, according to a person with knowledge of the transaction who asked not to be identified because terms aren't set. Proceeds from the benchmark sale will be used for general corporate purposes, according to a regulatory filing by the Moline, Illinois-based tractor maker.
Deere last sold bonds April 12, when it issued equal $500 million portions of 2.25 percent seven-year notes at 99.73 cents on the dollar to yield 87 basis points more than similar-maturity Treasuries and three-year, 0.875 percent debt at 99.94 cents with a 47 basis-point spread, according to data compiled by Bloomberg.
The Markit CDX North America Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses on corporate debt or to speculate on creditworthiness, added 1 basis point to a mid-price of 128.4 basis points at 11:54 a.m. in New York, according to prices compiled by Bloomberg.
The swaps measure increased as a composite index in Europe based on a survey of purchasing managers in manufacturing and services dropped to 46 in May from 46.7 in April, London-based Markit Economics said today. The reading is the lowest since June 2009, and points to a worsening sovereign debt crisis that may affect revenue for American corporations.
The swaps gauge typically rises as investor confidence deteriorates and falls as it improves. 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.
Retail investors added a net $252.8 million in May to U.S. funds that buy loans, based on weekly flow data, according to EPFR. That compares with $1.2 billion of inflows in April and $1.5 billion so far this year, the data show.
'Steady' Interest
"Even if on a retail level you have outflows," there is still "steady" interest from institutional investors such as collateralized obligations, said John Popp, head of Credit Suisse Group AG's credit investment group, which manages $16.2 billion.
Leveraged loans sold to non-bank lenders, such as CLOs and mutual funds, jumped 50 percent last month to $27.7 billion, from $18.5 billion in April, according to LCD data.
For the year, the pace of loan sales is slower than 2011. Companies sold a total $115.6 billion of the high-risk debt to non-bank lenders through May, down 27.5 percent from $159.5 billion in the same period last year, LCD data show.
Lending retrenchment is taking place as concerns deepen about a possible Greek departure from the euro area and as Spain calls for outside funds for the first time. Spanish Budget Minister Cristobal Montoro said in an interview with broadcaster Onda Cero today that European institutions should help shore up the nation's lenders.
The rate of commercial and industrial loan growth slowed in May, gaining 0.67 percentage points compared with 0.95 percentage points in April and growth of 3.5 percentage points in the first three months of the year.
Moody's Liquidity-Stress Index fell to a record-low in May as there are fewer companies with the lowest speculative-grade liquidity rating. That measure suggests that most borrowers can meet their obligations and covenants over the next year, according to a report published June 1 by the ratings company.
"Liquidity pressures are likely to mount if Europe's sovereign debt problems hurt the U.S. economy or access to credit markets," Moody's analysts led by Tom Marshella wrote in the report. "This would pressure cash flow, as well as make it more difficult for speculative-grade companies to refinance pending maturities and address potential covenant violations."
U.S. employment increased only 69,000 in May and job growth for the month before was revised down to 77,000, according to Labor Department figures released last week. Initial claims increased 10,000 to 383,000 during the week ending May 26 while the four-week moving average for claims increased 4,000 to 375,000, signaling some softening in the labor market.
GDP Revision
Gross domestic product climbed at a 1.9 percent annual rate from January through March, down from a previous estimate of 2.2 percent, according to revised Commerce Department figures released last week. The report also showed corporate profits rose at the slowest pace in more than three years and smaller wage gains at the end of last year.
"The loss of momentum in the domestic economy and the gathering global storm raise the likelihood of further policy easing at the next Fed meeting," JPMorgan Chase & Co. analysts led by Peter Acciavatti wrote in a June 1 report.
Credit Suisse is projecting U.S. leveraged loans returns this year to be in the range of 4 percent to 7 percent. For U.S. high-yield bonds, the lender expects gains of 7 percent to 10 percent, according to a June 4 research report.
The default rate for U.S. leveraged loans is expected to be between 1 percent and 2 percent in 2012, while U.S. high-yield debt is forecast to range between 1 percent and 3 percent, the report shows. The default rate on loans rose 0.64 percentage points from last year to 1.26 percent, according to Credit Suisse.
Treasuries rose today after the European debt turmoil pushed yields on haven U.S. government bonds to a record low last week. The yield on the 10-year Treasury note fell one basis point to 1.52 percent.
"The fact that the Treasury is rallying hurts the loan market in two ways — it's indicative of risk aversion and people are less worried about interest-rate duration and aren't looking for floating-rate product that will have limited rate exposure," Citigroup's Anderson said.
Leveraged-loan prices declined each of the past three weeks, wiping out nearly all of this year's gains after falling from this year's high of 94.56 cents on May 14.
"In a market where all risky asset classes traded off so much, loans of course will trade lower," said Brad Rogoff, head of credit strategy at Barclays Plc. "But loans have been hanging in better than bonds, not only because of resilient performance in the secured part of the capital structure but also there haven't been huge outflows from mutual funds."
Junk bonds lost 1.21 percent in May while leveraged loans declined 1.22 percent, according to the S&P/LSTA Index and Bank of America Merrill Lynch indexes. Year-to-date bonds returned 4.26 percent while loans have posted a gain of 3.48 percent.
"The month was a struggle for loans just as it was for any other asset class, but the relative health of that market feels better than any of the other risky asset classes," Rogoff said.
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