Corporate Bond Risk Soars as Subprime Mortgage Losses Spread

The risk of owning corporate bonds rose to the highest in at least three years after a German bank slashed its profit forecast because of ``massive uncertainty'' in the market for subprime mortgages and credit.
Indexes linked to credit-default swaps in Europe and the U.S. rose to the highest since they were created in 2004, showing that the perception of credit quality is deteriorating. Contracts on Dusseldorf-based IKB Deutsche Industriebank AG IKB, which allow investors to speculate on its ability to repay debt, jumped to six times the prices of a month ago. Goldman Sachs Group Inc. rose to the highest on record.
`It's pure fear,'' said Gary Jenkins, a partner at London- based hedge fund Synapse Investment Management, which manages $650 million of debt assets. Jenkins was head of fundamental credit at Deutsche Bank AG before joining Synapse in April. ``It's fear of the unknown, fear of hedge funds unwinding, fear of knock-on effects of the subprime meltdown.''
Investors are fleeing corporate credit, causing more than 40 companies to abandon or rework debt sales. The retreat has pushed yield premiums on corporate bonds to the highest relative to U.S. Treasuries since 2003.
Contracts on 10 million euros ($13.8 million) of debt included in the iTraxx Crossover Series 7 Index of 50 European companies rose as high as 504,000 euros before closing up 18,000 euros at 462,000 euros, according to JPMorgan Chase & Co. The CDX North American Investment-Grade Index rose as much as $22,000 to $103,000, Deutsche Bank AG prices show. The index traded at $87,250 as of 12:31 p.m. in New York.

Gaining Pace
Credit-default swaps have risen more quickly in the past two months than in any other eight-week span in the past seven years, Barclays Capital said in a report. The firm based its estimate on so-called QCX indexes that enable it to track credit-default swap benchmarks as if they had been created at the beginning of 2001.
Late payments and defaults among subprime borrowers, who have poor credit or high levels of debt, are at a 10-year high, according to Friedman Billings Ramsey Group in Arlington, Virginia. Delinquencies sparked a decline in the securities that package them.
The rout gained pace in mid-June, when two Bear Stearns Cos. hedge funds posted losses and later collapsed. It widened globally as Blackstone Group LP stepped in to advise Sydney-based Basis Capital Fund Management Ltd. and Absolute Capital Group Ltd., partly owned by ABN Amro Holding NV, froze investor accounts.

`Winds and Rain'
As investors balked at buying loans and bonds, banks were forced to take on at least $32 billion of debt to finance buyouts including the purchase of Chrysler Group by Cerberus Capital Management LP.
Banks are also on the hook for Kohlberg Kravis Roberts & Co.'s buyout of U.K. pharmacy chain Alliance Boots Plc, Europe's biggest leveraged buyout.
``The winds and rain have not fully subsided,'' Lehman Brothers Holdings Inc. fixed-income analysts led by Jack Malvey said in a research note dated today.
IKB, a bank that focuses on small and medium-sized companies, said in a statement today that profit will be ``significantly'' lower than forecast because of losses on bonds linked to subprime loans. Ten days ago, the company said it wouldn't be affected.

Concern Rise;
The bank replaced its chief executive officer and said its access to funding was threatened. State-owned KfW Group, which holds a 38 percent stake in IKB, said it will cover the company against potential losses.
Credit-default swap contracts based on 10 million euros of IKB debt, which traded at 15,000 euros a month ago, were at 95,000 euros today, according to Royal Bank of Scotland Group Plc.
The iTraxx Europe Series 7 Index of 125 companies with investment-grade credit ratings including Europe's major banks jumped 16,000 euros to 72,000 euros, signaling risk perceptions have increased, JPMorgan prices show. The rise was the biggest increase since the index started three years ago.
Credit-default swaps on New York-based Goldman Sachs, the world's biggest securities firm, rose $2,000 to $94,000 after earlier rising to $104,000, according to CMA Datavision.
Credit swaps on Fannie Mae and Freddie Mac, the U.S. government-chartered companies that are the largest providers of money for U.S. home loans, have tripled this month. Fannie Mae contracts are trading at $32,000 and Freddie at $30,000 today, according to CMA.
``There's a lot of pain out there, and there's a lot of risk aversion,'' said Abdul K. Hussain, a portfolio manager at Dubai, United Arab Emirates-based hedge fund Mashreq Capital DIFC Ltd., which manages $250 million in fixed-income assets. ``You can't go through the volatility we've seen in the past week without seeing longer term repercussions.''

`Significant Losses'
While Federal Reserve Chairman Ben S. Bernanke on July 19 predicted ``significant financial losses'' from the subprime rout, citing estimates of as high as $100 billion, U.S. Treasury Secretary Henry Paulson said in an interview last week that the turmoil doesn't pose a threat to the U.S. economy.
Risk premiums are rising even as the global corporate default rate hovers near its lowest in 12 years and most of the companies reporting second-quarter earnings post larger profits than analysts predicted.
The global default rate among speculative-grade companies in June was 1.4 percent, the lowest since March 1995, according to Moody's Investors Service. As of July 27, 65 percent of the 201 companies in the Standard & Poor's 500 index had reported higher profits than estimated, according to Bloomberg data.

Widening Spreads
The spread investors demand to own investment-grade corporate bonds instead of Treasuries widened 20 basis points last week to 128 basis points, according to index data compiled by Merrill Lynch & Co. Spreads on high-yield bonds rose 91 basis points to 428 basis points, the highest since May 2005, Merrill indexes show.
Still, that would be less than half that of the 1,120 basis points reach in 2002, based on the Merrill Lynch indexes. A basis point is 0.01 percentage point.
Investor confidence in high-risk, high-yield loans fell.
In the U.S., the LCDX index tied to loans of 100 companies dropped to as low as 90, the lowest since the index was created May 22, according to Goldman. The index was unchanged at 92 as of 11 a.m. in New York, Goldman prices show. In Europe, the iTraxx LevX Index of credit-default swaps on loans to 35 European companies dropped 2.25 to 92.5, according to Bear Stearns Cos., the lowest since that index started trading in October.
The CDX North America High-Yield Index of 100 companies, which falls as investor confidence deteriorates, earlier dropped 1.38 to 89.13 before rallying back to 90.75, according to Lehman Brothers Holdings Inc.
The price implies it costs about $535,000 to protect $10 million in junk bonds, down from $586,000 earlier today, according to a JPMorgan Chase model.