Commentary May 27, 2010, 5:00PM EST

When Banks Don't Trust Banks

(page 2 of 2)

Lower rates have also brought down borrowing costs for companies fortunate enough to live at the top of the credit food chain. Abbott Laboratories (ABT), maker of the lucrative arthritis drug Humira, sold $3 billion of bonds on May 24, its first offering in more than a year. The coupon on the biggest portion of the deal, a $1.25 billion slice due in 2040, was 5.3 percent, a full percentage point lower than similarly rated bonds due in more than 15 years, based on Bank of America Merrill Lynch (BAC) index data. "There is a flight to quality, to solid investment-grade companies," says Nicholas Pappas, co-head of flow credit trading in the Americas at Deutsche Bank (DB) in New York.

Even high-yield debt still has fans—or at least bargain hunters willing to swoop in when they spot an attractive price. After junk bonds gained a record 57.5 percent in 2009 and 7.1 percent through April of this year, the market is "correcting," says Jeff Peskind, founder of hedge fund Phoenix Investment Adviser in New York. He scooped up the bonds of credit-card processor First Data and other large leveraged buyouts as prices tumbled this month, anticipating a rebound. First Data, bought by KKR & Co. for $27.5 billion, has seen its bonds decline 17.5 percent this month through May 25, raising concerns among investors about the Atlanta-based company's ability to roll over the $14.3 billion of loans and bonds it has coming due by 2014.

First Data is not alone. Junk-rated borrowers, some of whom were taken private at the height of the leveraged buyout boom in 2007, have $1.25 trillion of debt coming due through 2015. Their prospects are, at best, mixed. "LBOs need growth to de-lever. They also need access to capital markets to continue pushing out maturities," says Jason Rosiak, the head fund manager overseeing $2.7 billion at Pacific Asset Management, an affiliate of Pacific Life Insurance in Newport Beach, Calif.

As for the ol' Libor, well, it could get worse before it gets better. Deepening concern about the quality of banks' collateral and attempts to regulate the banking industry could force it as high as 1.5 percent by September, says Neela Gollapudi, a strategist at Citigroup Global Markets (C) in New York.

That's still a safe distance from its peak. Thus far, market participants tend to agree on one point—if the European debt crisis is a contagion, it will probably not lead back into full-blown panic. The recent experience of a brutal, worldwide, coordinated market plunge left calluses, as well as a resolve not to be left out of the next buying opportunity of a lifetime. A lesson from 2008 is that those with the nerve to wade back into markets at their scary lows can reap remarkable profits; just because some investors head for the exits doesn't mean there will be a mad scramble. As Morgan Stanley (MS) strategists Laurence Mutkin and Elaine Lin put it in a May 26 report: "The repricing of spreads in financing markets, sharp and swift though it has been, still does not amount to evidence of anything like the levels of stress during 2008. Nor, given that central banks have already revived their backstop measures, do we think that it will. Financing markets remain orderly and open."

Paulden is a reporter for Bloomberg News. With Tim Catts and Shannon Harrington.

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