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Credit Markets: Europe Continues To Cloud Credit Markets
Dow Jones, 8 June 2010

Worries over Europe continue to keep hesitant investors' cash on the sidelines. Fitch Ratings said Tuesday that the U.K. faces a "formidable" challenge in returning to fiscal austerity. The news from Fitch has further stirred up the anxiety among investors already on edge over the euro zone's sovereign-debt problems.

The ongoing flight to safety drove demand of $36 billion sale in three-year U.S. Treasury notes, setting up Wednesday's auction of 10-year bonds.

Some action emerged on the investment-grade front after two days with no new issues. Two high-yield deals were finalized as well.

"Most of the borrowers basically need a couple of days of steady markets before they jump back in," said Richard Lee, managing director of fixed income at Wall Street Access. "I think people are really spooked right now."

In addition to European woes, Lee noted that Goldman Sachs Group Inc.'s (GS) subpoena by the U.S. Financial Crisis Inquiry Commission could further stoke investors' hesitancy.


The pace increased slightly for investment-grade issuance. Altria Group Inc. (MO) priced an $800 million, 5.25-year deal at 99.574. Microsoft Corp. (MSFT) said it will offer as much as $1.15 billion in three-year convertible notes to select investors to repay short-term debt.

Issuers have been reluctant to add supply so far this year. Through May, investment-grade issues numbered just 208, compared to 305 issues through the same period last year, according to Wall Street Access. For the trading days so far in June, the volume of U.S.-marketed investment-grade deals has been $5.15 billion compared to $1.34 billion for the first eight days of May, according to Dealogic.

Uncertainty remained in Europe, as the cost of insuring debt issued by financial institutions widened on fresh fears of lenders' exposure in the region. Insurance for debt tied to Royal Bank of Scotland Group PLC (RBS, RBS.LN) rose 7.98 basis points to 245.20 basis points and, for Deutsche Bank AG (DB, DBK.XE), rose 5.69 basis points to 187.11 basis points, according to CMA.

The Markit CDX North America Investment Grade index, the benchmark U.S. credit default swaps measure, was flat as of 4:20 EDT, trading at 129.5 basis points, compared to 129.89 at Monday's close, according to Markit.

High Yield 

Two issuers sold deals Tuesday as companies looked to score high-yield financing before the market all but closes for business over the summer. Triumph Group Inc. (TGI) and BWAY Holding Co. (BWY), both in the midst of acquisition deals, sold a combined $550 million in eight-year senior notes.
Triumph sold $350 million in notes at 8.75%. Shareholders last week approved a company plan to acquire Vought Aircraft. And BWAY sold $205 million in notes at a 10.25% yield as part of the financing of its takeover by private equity firm Madison Dearborn Partners.

The secondary high-yield market softened despite new issuance, with the cash bonds mixed to lower in modest trade volume and the Markit CDX North America High Yield Index down 0.3 point to 92.55, according to index administrator Markit.

In leveraged loans, Bank of America Corp. (BAC) tacked an additional 125 basis points onto its deal for Cincinnati Bell. The $760 million term loan is now talked at 500 basis points over the London interbank offered rate, which tracks the amount banks charge one another to borrow, and cut a point off the price for original buyers as commitments were set to be due Tuesday.

And TransUnion is shopping a $940 million term loan at 475 basis points over Libor, with a discount of 1.5 cents on the dollar for original buyers. It's part of a financing deal that includes $645 million in eight-year senior notes set to price Wednesday. Deutsche Bank is leading the loan, while J.P. Morgan Chase & Co. is running the bonds.

Agency Mortgages 

Agency mortgage securities continued to see light activity as investors were waiting for weaker risk premiums. The previous up-in-coupon trade, as investors bought higher coupon securities to avoid risk of prepayment in the recently issued lower coupons, also faded. Risk premiums are one basis point wider at 146 basis points over comparable Treasury yields.

Meanwhile, the rate of prepayment on these loans slowed more than expected among Fannie Mae (FNM) and Freddie Mac (FRE) securities, according to the latest prepayment report. In sharp contrast, Ginnie Mae securities saw a spike of 14% in their rate of prepayment. This is expected to usher in more months of higher prepayments.

Asset-Backed Securities 

There's a deafening silence in the consumer loan-backed bond market as broader market volatility and regulatory changes have muffled the sale of new issues, which help credit flow in the economy.

No new bonds have been sold in this $700 billion market in two and a half weeks, and only $52 billion has been sold so far this year. At this pace, issuance for the year likely will fall short of the $140 billion forecast in January. That would be comparable to the amount sold in 2009, but far below the $700 billion sold in 2006, according to Asset-Backed Alert, a trade publication.
Spreads on new deals have widened as much as 0.20 percentage point, said Paul Jablansky, senior ABS strategist at the Royal Bank of Scotland in Stamford, Conn., noting that is because of a "fair amount of market volatility."

Not only are there worries over euro-zone debt, there are also concerns about the tension in Korea and uncertainty about economic growth in the U.S.

Adding to that is a recent change in Securities and Exchange Commission rules governing disclosure to rating agencies. As per the new rules, issuers must share information about deals even with rating agencies they haven't been hired to grade the deals.

"Issuers are hesitant to be the first to go through the new rating agency regulatory process," Jablansky said.



Prices of long-dated Treasurys rose Tuesday afternoon as investors clamored for safe assets on sovereign-debt problems in Europe, lifting demand for $36 billion sale in three-year notes.

Short-dated Treasurys also erased losses following the auction, the first leg of this week's $70 billion in new government notes and bonds. The three-year notes were offered at 1.22%, the second-lowest auctioned yield for the maturity, allowing the U.S. government to fund economic-stimulus bills and budget deficits at historically low borrowing costs.

"A good auction despite low yields," said Suvrat Prakash, an interest-rate strategist at BNP Paribas Securities Corp. in New York. "It tells you that in an uncertain environment with investors worried about what could come out of the sovereign-debt story in Europe, Treasury yields could go lower."

As of 2 p.m. EDT, the price of the benchmark 10-year note was 6/32 higher, with the yield down 2.4 basis points at 3.160%. The 30-year bond was 20/32 higher and the yield was down by 3.7 basis points to 4.088%. The three-year note was flat to yield 1.166%. Bond yields move inversely to prices.

The 10-year Treasury note's yield, the benchmark for consumer and corporate borrowings, fell as low as 3.059% on May 25, the weakest level since April 2009 as euro-zone debt fears fueled flight-to-safety demand in Treasurys last month.

Despite the lower yields, the three-year note sale enticed an amount of bids that was 3.23 times the amount on offer, above the average of 3.08 for the previous four auctions.

The indirect bid, a proxy for foreign demand, was 47%, compared to the average of 51.5% for the previous four auctions. The direct bid, a category of bids from non-primary dealers, banks, money managers and depository institutions who have direct accounts to submit bids to the Treasury auctions, was 16%. It compared to the average of 11.9% for the previous four sales.

Some market participants noted that the shrinking auction size for the three-year maturity made the supply easier to absorb. The size was $2 billion less than the offering in May and $4 billion less than the sale in April.

The bigger test would come on two offerings on long-dated maturities--$21 billion in 10-year notes Wednesday and $13 billion in 30-year bonds Thursday. These two sales are additional offerings from May's supply, known as reopened issues. Their sizes remain unchanged from the reopening sales back in April.


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