By Kate Haywood, John Detrixhe and Caroline Hyde April 7 (Bloomberg) — Emerging market bonds, with returns four times those of U.S. corporate debt, are extending their lead on signs that developing economies are growing faster. Debt issued by emerging market borrowers returned 11.3 percent this year through yesterday, outpacing U.S. company bonds which have gained 2.79 percent, according to Bank of America Merrill Lynch index data. Petroleos de Venezuela SA , the state oil producer known as PDVSA, has led emerging-market debt’s 0.09 percent gain in April, which compares with a loss of 0.39 percent for U.S. corporate bonds. Developing market debt is soaring as the International Monetary Fund forecasts their economies will expand 6 percent this year, almost three times more rapidly than advanced nations. While the European Union tries to contain Greece’s budget deficit, the largest in the euro region, the U.S. is issuing record amounts of debt to help recover from its worst financial crisis since the 1930s. “The blowout of developed countries’ fiscal deficits has caused people to re-assess emerging markets as an asset class,” said Brett Diment , the head of emerging-market debt in London at Aberdeen Asset Management Plc. “The days when they were seen as a risky bet are gone.” Investor allocations to emerging-market funds have surged, prompting JPMorgan Chase & Co. to boost its inflow forecast to $40 billion to $45 billion this year, from a range of $30 billion to $35 billion, analysts led by Joyce Chang in New York wrote in a March 11 report. The asset class is attracting investors seeking higher yields as the economies in developed nations take longer to recover, encouraging central banks to keep benchmark interest rates at record lows, said Werner Gey Van Pittius , emerging- markets money manager at Investec Asset Management in London. Global Default Rate Elsewhere in credit markets, the 12-month global default rate for high-yield, high-risk debt fell to 9.9 percent in the first quarter, from 13 percent at the end of 2009, according to Moody’s Investors Service. Lorillard Inc. , the third-largest U.S. tobacco company, sold $1 billion of debt. Delinquencies on commercial mortgages bundled and sold as bonds may top 10 percent this year, Deutsche Bank AG said. The 12-month global default rate will drop to 2.8 percent by yearend, then decline to 2.4 percent by April 2011, Moody’s said in a report distributed today. In the U.S., the rate is expected to be higher, ending the year at 3.1 percent. Based on dollar volume, 11.3 percent of U.S. speculative-grade bonds were in default in the first quarter, down from 16.6 percent in the previous quarter, the New York-based ratings company said. U.S. leveraged-loan defaults were 10.3 percent, down from 11.9 percent in the prior three months, according to Moody’s. High-yield debt is rated below Baa3 by Moody’s and lower than BBB- by Standard & Poor’s. Lorillard Offering Lorillard sold $750 million of 10-year notes that yield 300 basis points more than similar-maturity Treasuries and $250 million of 30-year bonds paying a spread of 340 basis points, according to data compiled by Bloomberg. The debt was sold through the company’s Lorillard Tobacco Co. unit. A basis point is 0.01 percentage point. The Greensboro, North Carolina-based maker of Newport cigarettes last sold debt on June 18, issuing $750 million of 8.125 percent, 10-year notes at par, or a spread of 428.9 basis points, Bloomberg data show. The delinquency rate for loans supporting commercial mortgage-backed securities more than tripled to 6.74 percent in March from 1.91 percent a year earlier, Deutsche Bank analysts Richard Parkus and Harris Trifon wrote in a report. With delinquencies rising 0.75 percentage point last month, the rate of increase shows little sign of slowing as loan servicers struggle to resolve a growing pipeline of troubled debt, the New York-based analysts said. Corporate Credit Risk Credit-default swaps linked to Greece sovereign debt rose higher than those tied to Iceland for the first time, helping propel a benchmark indicator of U.S. corporate credit risk to its biggest jump in two weeks. The Markit CDX North America Investment Grade Index Series 14 rose 3.4 basis points to a mid-price of 87.5 basis points as of 4:19 p.m. in New York, according to Markit Group Ltd. In London, the Markit iTraxx Europe Index of credit-default swaps on 125 investment-grade companies climbed 3.3 basis points to a mid-price of 80 basis points, Markit prices show. The indexes typically increase as investor confidence deteriorates and fall as it improves. Greece, Iceland Swaps tied to Greece rose to 415 basis points today while those on Iceland traded at about 400 basis points, according to Markit data. Greece may default on its debt as soon as this year without “extraordinary” financial assistance from the EU and IMF, said Stephen Jen , managing director at the hedge fund BlueGold Capital Management LLP in London. Iceland had to resort to a $4.6 billion bailout led by the IMF after its three biggest banks collapsed in October 2008, leaving creditors wondering how they would recoup about $80 billion in debt. Credit swaps pay the difference between the value of defaulted debt and its face value should the borrower fail to meet its obligations. A basis point equals $1,000 annually on a contract protecting $10 million of debt. Economic Driver Emerging-market bonds are rallying as their economies expand 6 percent this year after growing 2.1 percent in 2009, while advanced nations will rebound to 2.1 percent growth after contracting 3.2 percent last year, according to IMF forecasts. “Most investors now share the view that emerging markets will be the driver of global growth over the medium term,” said Nick Darrant , who runs emerging market syndicate at Credit Agricole CIB in London. “The concept of flight to quality has been fundamentally undermined by the enduring strength of emerging markets. We are witnessing a paradigm shift.” PDVSA, based in Caracas, led Bank of America Merrill Lynch’s emerging-market index of top 50 issuers with a 6.64 percent return this month through April 6, index data show. The company’s 5.5 percent bonds due in 2037 were priced at 51 cents on the dollar to yield 697 basis points more than benchmark rates, index data show. ‘Subpar’ Growth “Investors will continue to search the globe for attractive fixed income assets” as the economic outlook in most developed countries remains “subdued,” Mark Kiesel , global head of corporate bond portfolio management at Pacific Investment Management Co. wrote in a report posted March 24 on the Newport Beach, California-based company’s Web site . “High- quality credit assets are likely to outperform lower-quality alternatives, which will become increasingly vulnerable to subpar economic growth in developed economies.” The challenges facing Greece are similar to those that confronted Argentina, which defaulted on $95 billion of debt in 2001, Jen said in an interview today. Greece’s austerity measures to narrow Greece’s budget deficit may drive the Mediterranean nation into a recession, he said. “A default may be ultimately unavoidable,” Jen said. In the U.S., President Barack Obama has increased U.S. marketable debt to an unprecedented $7.41 trillion to fund a budget deficit the government predicts will swell to a record $1.6 trillion in the fiscal year ending Sept. 30. Developed economies face “headwinds” stemming from a collapsed housing bubble, substantial household debt and sovereign deficits and budgetary concerns that are “much more severe and more serious than in most emerging markets,” said Torsten Slok , senior economist at Deutsche Bank in New York. Emerging market corporate bond defaults may fall “sharply” to 1.8 percent this year, according to the JPMorgan analysts. “Emerging market countries are now on a much stronger footing relative to developed countries and we are very optimistic on returns,” said Investec’s Van Pittius. “The risk of a currency crisis and sovereign default in most emerging markets is pretty low at the moment.” To contact the reporters on this story: Kate Haywood in London at khaywood@bloomberg.net ; John Detrixhe in New York at jdetrixhe1@bloomberg.net ; Caroline Hyde at chyde3@bloomberg.net
