The cost to protect (ETN:US) against losses on debt of the Cleveland-based company jumped 10.9 basis points to a mid-price of 96.9 basis points at 3:40 p.m. in New York, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. The swaps are at the highest level since they were 97.9 basis points on Dec. 1.
The contracts linked to Eaton surged as the company, which received bridge financing for $6.75 billion, said in a statement it plans to refinance the borrowing through debt issuance, cash on hand and a possible sale of assets. The company has $3.35 billion of bonds outstanding, according to data compiled by Bloomberg.
“Additional financial leverage adds risk to bondholders,” Morningstar Inc. (MORN:US) credit analyst Rick Tauber said in a telephone interview. “I would expect a ratings downgrade of one to two notches due to the magnitude of the change.”
Eaton is rated A3, four levels above junk grade, by Moody’s Investors Service and an equivalent A- by Standard & Poor’s. Both ratings firms announced today that they have placed the company on review for a possible downgrade. Eaton said it is targeting a return to an A credit rating for its long-term debt in a presentation for investors.
‘Disciplined and Focused’
“The fact that they want to achieve a mid-A rating tells me they will be disciplined and focused toward doing that,” Tauber said. “But they would have to turn off their acquisition spigot.” Eaton had announced the acquisition of Jeil Hydraulics Co. in April and Istanbul-based Polimer Kaucuk Sanayi ve Pazarlama A.S. in February, Bloomberg data show.
A benchmark gauge of U.S. corporate credit risk fell from the highest level of the year as China pledged to take measures to boost economic growth.
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, dropped 5.5 basis points to a mid-price of 117.9 basis points at 5:31 p.m., Bloomberg prices show. The index had closed at 123.4 last week, the highest since Dec. 21.
The gauge declined as Chinese Premier Wen Jiabao said over the weekend that the country will focus on bolstering growth. Economic expansion in the world’s second-largest economy is critical for American corporations relying on international activity to expand sales and improve balance sheets.
“It was mostly a technical driven rally,” Randy Woodbury, a fixed-income credit trader at Des Moines, Iowa-based Principal Global Investors said. “People who had bought protection on the index had made some money in the last two weeks and had decided to take that bet off and close their positions.”
The fall in the swaps gauge does not indicate that it will tighten appreciably in the near term, John Tierney, a credit markets strategist at Deutsche Bank AG, said in a telephone interview. “The markets are going to stay on edge for the next two months.”
The swaps index typically falls as investor confidence improves and rises as it deteriorates. Swaps contracts 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.
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