Loans Expert

Leveraged loans are outperforming high-yield, high-risk bonds in the U.S. after lagging behind the last four years as the Federal Reserve takes steps to withdraw the unprecedented amount of cash it pumped into the economy.

Speculative-grade loans gained 1.91 percent this year through Feb. 19, according to Standard & Poor’s. That compares with 1.137 percent for junk bonds, Bank of America Merrill Lynch’s U.S. High Yield Master II index shows. Higher benchmark borrowing costs tend to increase rates on loans, which are adjustable, boosting returns.

“At some point the stimulus has to begin coming out,” said Greg Stoeckle, a money manager who handles about $10 billion of loan funds at Invesco Inc. in New York and is chairman of the Loan Syndication and Trading Association. “The discount rate increase is the Fed saying this is just a warning shot.”

Funds buying leveraged loans attracted $1.38 billion this year, while investors took out $440 million from the high-yield bond market, according to Deutsche Bank AG. The Fed, seeking to encourage financial institutions to rely more on money markets than the central bank for short-term liquidity, raised the discount rate by a quarter percentage point to 0.75 percent on Feb. 18. The next day, the cost of borrowing in dollars for 12 months rose the most this year.

Futures, Sales

Futures for the three-month London interbank offered rate show investors are speculating the lending benchmark will rise to 1.29 percent in a year, and to 3.63 percent by Feb. 25, 2013, data compiled by Bloomberg show. The rate was set at 25.194 basis points, or 0.25194 percentage point, on Feb. 19.

Elsewhere in credit markets, the extra yield investors demand to own corporate bonds instead of Treasuries fell last week for the first time since the period ended Jan. 15, narrowing 2 basis points to 169, Bank of America Merrill Lynch’s Global Broad Market Corporate Index showed. Yields overall rose to 4.183 percent from 4.134 percent.

Corporate bond sales worldwide fell to $23.4 billion last week, the slowest in 2010 and below the past year’s weekly average of about $60 billion, as rising market volatility dissuades investors from committing capital, Bloomberg data show. Issuance totaled $28.8 billion the previous week.

Companies have sold $109 billion of debt this month, compared with $206 billion in the same period a year earlier. Sales this year are $394 billion, versus $587 billion in 2009.

Credit-Default Swaps

A benchmark gauge of corporate credit risk in the U.S. had its biggest weekly drop in seven weeks, indicating improving perceptions of credit quality.

The Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt, dropped 2.9 basis points to 90.9, the lowest since Jan. 21, according to CMA DataVision. The week’s decline of 8 basis points was the biggest since the period ended Jan. 8, CMA prices show.

Credit-default swaps on the Markit iTraxx Crossover Index of 50 European companies with mostly high-yield credit ratings declined 14 basis points to 454 as of 9:24 a.m. in London today, the lowest in almost three weeks, JPMorgan Chase & Co. prices show. The Markit iTraxx Europe Index of 125 investment-grade companies fell 2.25 basis points to 82.25.

Asian risk benchmarks today fell to the lowest in almost three weeks. The Markit iTraxx Asia index of 50 borrowers outside Japan dropped 5 basis points to 113, Citigroup Inc. prices show.

Motorola Bonds

Credit swaps pay the buyer face value if a borrower defaults in exchange for the underlying securities or the cash equivalent. A basis point equals $1,000 a year on a contract protecting $10 million of debt.

Motorola Inc. bonds are surging, putting them among the best performing U.S. investment-grade debt this month. Its 6.5 percent notes due in 2025 returned 8.07 percent, according to Bank of America Merrill Lynch index data.

The Schaumburg, Illinois-based company plans to split in two, “a move that carries positive credit implications because it will strip out Motorola’s volatile handset business from the unit that will carry the debt,” Moody’s Investors Service analysts led by Matthew Jones wrote last week in a report.

At the other end of the spectrum, U.S. Concrete Inc.’s $272.6 million of 8.375 percent securities due in 2014 tumbled 21.5 percent this month, the worst performance in the junk bond market, according Bank of America Merrill Lynch index data. The Houston-based construction materials supplier said Feb. 19 it hired firms to help restructure its debt and got a waiver on an interest payment due in April.

Fed’s Target Rate

“The big question hasn’t been whether rates will go up, it has been when they will rise,” said AJ Murphy, head of leveraged loans capital markets for the Americas at Bank of America Merrill Lynch in New York. “When rates start rising, it’ll certainly speed things along, every basis point Libor goes up is money in the pocket of loan investors.”

Libor for 12 months climbed more than 2 basis points on Feb. 19 to 87.75 basis points, the British Bankers’ Association said. It was the biggest increase since Dec. 7.

Loan Funds Grow

Bank loan funds attracted as much as $271 million per week since the beginning of the year, data compiled from Deutsche Bank reports show. Meanwhile, investors reversed money flows to junk-bond funds after the first three weeks, withdrawing as much as $984 million a week, the most since September 2005.

In Europe, high-yield bonds and leveraged loans diverged last week, with bonds gaining even as loans had their biggest weekly slide since Jan. 22, 2009. The average bid of actively traded leveraged loans in Europe tumbled 109 basis points to 94.61 percent of face value, according to S&P’s LCD unit. The index fell 0.6 percent this year.

High-yield bonds rose, with spreads tightening to 745 basis points on Feb. 19, from 766 a week earlier, according to Bank of America Merrill Lynch’s Euro High Yield Constrained Index. Returns totaled 0.62 percent last week, bringing the gains for the year to 2.79 percent, the data show.

High-yield, high-risk, or junk, debt is rated below Baa3 by Moody’s and lower than BBB- by S&P.

“Everybody is feeling nervous about the increased sovereign risk issues,” said Michael Johnson, head of European leveraged capital markets at Cantor Fitzgerald & Co. in London.

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Tags: Credit Markets, Loans