NEW YORK (AP) — The recent decline in bank-to-bank lending rates is having no effect on corporate bonds, which continue to plunge in value — a sign that the market believes more loan defaults and a wave of bankruptcies are ahead for U.S. companies.
There were some positive signals from the markets Tuesday — the Federal Reserve reported that issuance of the short-term corporate debt known as commercial paper spiked Monday, a turnaround from a prolonged slump.
Still, market rates on corporate bonds have continued to rise compared to Treasury yields for nine straight days, said John Atkins, a fixed-income analyst at IDEAGlobal.com. This trend is hitting non-investment grade bonds, or junk bonds, the hardest, but is occurring in investment grade bonds as well.
About half of rated U.S. companies are non-investment grade, according to Standard & Poor's.
Junk bonds simply aren't being issued right now, but their rates in the market for existing bonds determine how much companies would have to pay if they needed to issue them to raise cash. If these rates keep rising, the cost of financing through the corporate bond market will become cost-prohibitive for many companies — compounding the problems that the economy is dealing them.
The bond default rate for junk bonds rose to 2.86 percent by the end of September from 0.97 percent at the end of 2007, S&P said. Many analysts predict that percentage rate will reach double digits next year.
"Defaults will start stacking up quickly — names you know, things you drive by on the way to work," Atkins said. When companies default on their loans, they often have to file for bankruptcy.
The U.S. government, like other governments, has been pumping money into banks to keep them afloat and available to make loans.
But that protection "doesn't extend out to the entire universe of nonfinancial corporates," said Michael Feroli, a JPMorgan Chase economist. "It's hard to argue that certain manufacturers are systemically important."
Although the world's banks are more flush with cash than they were a few weeks ago, participants in the credit markets are now wondering how that capital is going to be used. Companies that are in decent shape are hunkering down, trimming their payrolls and putting off growth plans so they won't have to borrow money.
Whirlpool Corp., following announcements of massive layoffs at Xerox Corp. and Merck & Co., said it was cutting about 5,000 jobs by the end of next year and suspending the $500 million share-repurchase program it announced in April.
Meanwhile, companies that are in poorer shape can't get a loan.
With some companies loath to borrow to expand their business, and other companies struggling to stay afloat in a climate where banks only want to lend to the most creditworthy borrowers, the length and depth of the economic downturn — and how many more job cuts lie ahead — remains uncertain.
"We're just going into the worst part of this," Feroli said.
The cost of insuring against investment-grade corporate bond defaults, as measured by the Markit CDX North America Investment Grade Index, slipped Tuesday, according to Phoenix Partners Group. This is a good sign, suggesting that overall, people were less worried about bond defaults Tuesday than they were Monday.
But that index is a broad measure of the market. Rates on certain financial institutions — such as Goldman Sachs Group Inc. and Morgan Stanley — shot higher, indicating rising uncertainty about those institutions. And Atkins pointed out that individual retailers including Target Corp. and Wal-Mart Stores Inc. have seen huge rises this month in their bond default insurance contracts, known as credit default swaps. This indicates that concerns about bond defaults have spread to the troubled retail sector.
With investors still extremely risk averse, demand for Treasury bills, considered the safest assets around, remained high Tuesday — although Wall Street had a huge advance, with the Dow Jones industrials rising nearly 900 points. The three-month T-bill's yield was at 0.74 percent, down slightly from 0.77 percent late Monday. The discount rate was 0.73 percent.
T-bill demand has stayed high even as bank-to-bank lending rates extended a two-week decline.
The three-month dollar London Interbank Offered Rate, or Libor, fell to 3.47 percent from 3.51 percent Monday. Libor is a key interbank lending rate to which many consumer loans — including adjustable-rate mortgages — are linked.
Meanwhile, it appears the Fed's program to buy three-month commercial paper is helping to boost that market. Commercial paper is the short-term debt that companies sell to finance their day-to-day operations, such as maintaining inventories and payrolls.
The Fed reported Tuesday a spike in total volumes for commercial paper with maturities over 81 days to $67.1 billion Monday. That's up from daily volumes last week ranging from $3.6 billion and $7.8 billion. Monday's jump in issuance occurred in the commercial paper sold by financial companies, and the commercial paper backed by assets such as mortgages and credit card debt.
And longer-term Treasurys slipped as investors absorbed more government debt supply and anticipated that the Fed would lower the target fed funds rate by a half-point on Wednesday.
The 2-year note fell 3/32 to 100 25/32 and yielded 1.58 percent, up from 1.59 percent late Friday. The 10-year note fell 1 11/32 to 101 7/32 and yielded 3.84 percent, up from 3.69 percent. The 30-year bond fell 2 23/32 to 105 1/32 and yielded 4.20 percent, up from 4.04 percent.
The Treasury auctioned $34 billion in 2-year notes Tuesday, and is set to auction 5-year notes on Wednesday.
