By Hamish Risk and Shannon D. Harrington
July 23 (Bloomberg) -- The risk of owning corporate bonds rose to the highest in more than two years in the U.S. and Europe on concern hedge funds may have to sell assets to cover losses, according to traders of credit-default swaps.
Contracts on $10 million of debt in the CDX North America Crossover Index of 35 companies jumped $20,000 to $297,000 as of 4:57 p.m. in New York, according to Deutsche Bank AG. The iTraxx Crossover Series 7 Index of 50 European companies rose as much as 24,000 euros ($33,116) to 367,000 euros before closing at 350,000 euros in London, Deutsche Bank prices show.
``We are close to specific levels where hedge funds may be forced to unwind positions,'' Jochen Felsenheimer, head of credit derivatives strategy at UniCredit SpA, said in an interview from Munich. That will create ``additional pressure'' and may send the iTraxx Crossover index to 400,000 euros.
Hedge funds typically use borrowed money to speculate on corporate debt and some may be forced to close money-losing positions to repay loans, Felsenheimer said.
Risk premiums have surged in the past month as concerns about losses from subprime mortgage securities caused investors to shed risk using the indexes and as investors grew skittish about the debt loads companies have been taking on through leveraged buyouts.
The iTraxx and CDX indexes last week rose the most since 2004 after Bear Stearns Cos. told investors in two funds they'll get little if any money back after declines in U.S. subprime mortgage securities. The indexes, which rise as perceptions of credit quality deteriorate, have more than doubled since the start of June.
``We can't identify a near-term catalyst that might lead to a sustained rally'' in corporate debt, Credit Suisse Group strategists led by Ken Elgarten in New York wrote in a research note published today.
High-Yield Loans
Investor confidence in high-yield loans fell a sixth day after Chrysler last week boosted the interest rates it's willing to pay investors to absorb more than $20 billion in debt needed to finance its takeover by Cerberus Capital Management LP.
Banks working for New York-based private equity firm Kohlberg Kravis Roberts & Co. also postponed a deadline to finance the acquisition of U.K. pharmacist Alliance Boots Plc, Europe's biggest leveraged buyout.
The LCDX index, tied to credit-default swaps on high-yield, high-risk loans to 100 U.S. companies, dropped 0.6 to 94.40 as of 5:06 p.m. in New York and traded as low as 94.25, according to Goldman, Sachs & Co. It fell to 94.1 on July 20, the lowest since it started trading on May 22. The iTraxx LevX Index on high-yield loans in Europe fell to a record 95.54 before rebounding to 96.12 in London, according to Markit Group Ltd.
Expedia
At least 20 companies have canceled or postponed debt offerings since June 26 as investors demand bigger premiums and tighter lending standards. Internet travel agency Expedia Inc. today scaled back plans to buy back almost half its shares outstanding because it couldn't find acceptable financing. The company now plans to buy back 8 percent of common stock.
The perceived risk of owning Expedia's bonds fell to the lowest since July 5 after the news. Standard & Poor's had cut the Bellevue, Washington-based company to speculative-grade on concerns about the debt it would take on to finance the buyback. Five-year Expedia credit-default swaps dropped $75,000 to $228,000, according to CMA Datavision in New York.
An index that includes Expedia and tracks the risk of owning investment-grade bonds rose today. The CDX North America Investment Grade Index rose $1,750 to $54,250, according to Deutsche Bank prices.
`Crucial Juncture'
``There is a chance that wider spreads are making the situation more worrying, especially with all the leverage in the system,'' Jim Reid, head of fundamental credit strategy at Deutsche Bank in London, said in a note to clients today. ``We are close to a crucial juncture for credit.''
In credit-default swaps, the buyer pays an annual premium to guard against a borrower failing to pay its debts. In a default, the buyer gets paid the full amount insured, and hands over defaulted loans or bonds to the swap seller.
The cost of the derivatives typically declines when creditworthiness improves, and rise when it worsens. The LCDX and LevX indexes fall as perceived risk increases.
A derivative is a financial obligation whose value is derived from such underlying assets as debt and equity, commodities and currencies.
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