By Dena Aubin
NEW YORK (Reuters) - Bonds of U.S. banks and brokers, among the worst performers last year, should turn around in 2008, helped by interest rate cuts and capital infusions, Bank of America strategists said on Thursday.
"The stuff that hurt you the most in terms of 2007 performance, we think at the start of 2008 will be the best performers," Jeff Rosenberg, head of credit strategy for Bank of America, said on a conference call.
Bond insurers, mortgage insurers and homebuilders should also perform well as liquidity improves, according to Bank of America strategists.
Though financial companies and homebuilders still face head winds, the wide yield spreads on their bonds already reflect the risks, bank strategists said.
U.S. high-grade issuance should remain healthy this year, exceeding $1 trillion, compared with last year's record $978 billion, as low yields on benchmark U.S. Treasuries keep borrowing rates attractive, said Jim Probert, Bank of America's head of high-grade syndicate.
About $550 million of maturing debt in 2008 will trigger a large amount of refinancings, while mergers will remain a significant driver of issuance, though down from last year's pace, Probert said.
He expects $70 billion of U.S. high-grade supply in January, basically in line with the previous three years and down just slightly from last January's $80 billion. Issuance should accelerate after banks report earnings around the middle of this month and come out of their blackout periods, he said.
Helped by a rebound in the financial sector, U.S. investment-grade corporate bonds overall should perform well at the start of the year, Bank of America said.
For the first time in three years, the bank has started the year with a "tactical overweight" recommendation on U.S. corporate bonds, meaning they expect them to outperform over the short term.
"We see a lot of continued fundamental issues facing the credit market, but we also a see tremendous amount of risk priced into the market and factors that we think will help dissipate, at least initially, some of those risks," Rosenberg said.
Continued Federal Reserve interest rate cuts should help ease a liquidity crunch, while the passing of seasonal, end-of-year liquidity problems should also help, Rosenberg said.
Capital infusions and balance sheet repair by financial companies should reduce leverage in that sector, which is positive for credit and less so for shareholders, he said. As that trend continues, financial companies' bonds should outperform shares, he said.
Bank of America also looks for high-yield bond defaults to remain benign, at 2 to 3 percent this year, in contrast to Moody's Investors Service's forecast for a 4.7 percent rate.
Companies still have a cushion of liquidity after borrowing long-term debt over the past several years, Rosenberg said. That liquidity reserve, along with higher inflation, could help keep defaults low, he said.
Inflation typically helps borrowers because their interest costs remain fixed, but they can pay them cheaper, inflated dollars.
