Auto woes intensify U.S. junk bond losses

NEW YORK (Reuters) - Fears of bankruptcy by a major automaker are intensifying the worst losses ever in U.S. junk bonds, pushing yields higher and raising default risks as more companies are shut off from funding.

Only one U.S. company has managed to sell junk bonds since the end of September as yields of 20 percent or more make issuance too costly for most borrowers.

Contagion from an ailing mortgage market is also hurting high-yield bonds, strategists said. Mortgage-backed bonds sold off after U.S. Treasury Secretary Henry Paulson last Wednesday backed away from buying troubled mortgage assets with a $700 billion bailout fund.

"That pulled the rug out from underneath the mortgage market," said veteran high-yield strategist Christopher Garman. "There's enough of a correlation across all these spread assets to also drag the high yield market down," he said.

With just one $700 million sale completed, junk bond issuance is on pace for the slowest quarter since the third quarter of 1991, when the market was still recovering from the bankruptcy of Drexel Burnham Lambert. Drexel collapsed after its star trader, Michael Milken, was indicted on racketeering charges, sending the junk bond market into a tailspin.

DEFAULTS RISING

The high yields are setting the market up for major gains once it recovers, but investors are too leery of defaults and an uncertain economy to begin buying, said Kingman Penniman, president of high-yield research firm KDP Investment Advisors.

"High yield loses more in a month now than we've ever lost in a year prior to this in terms of total returns," Penniman said.

Junk bonds have lost 28.4 percent year to date, including 4.3 percent so far in November and 16.3 percent in October, according to Merrill Lynch data. In 1990, the year of Drexel's bankruptcy, they lost just 4.4 percent.

About 80 percent of all high-yield issues are now trading at "distressed" levels, pointing to the highest default rate since the Great Depression, or about 18 percent, Garman said.

Bonds in the auto sector have lost nearly 42 percent year to date, according to Merrill Lynch data.

U.S. auto executives on Wednesday told a U.S. House Financial Services Committee that their industry was headed for disaster without government support.

A proposed bailout failed to gain traction in Congress, however. The chairman of the U.S. Senate Banking Committee, Connecticut Democrat Christopher Dodd, said it looks unlikely that Congress will come to agreement this week on the assistance package.

RIPPLE EFFECTS UNMEASURABLE

"A bankruptcy would just be horrific," said Penniman. "It would have a ripple effect that I don't know if anybody could quantify."

Bonds of Ford Motor Co (F.N) and General Motors Corp GM.N tumbled on Wednesday as uncertainty lingered about the fate of the government rescue.

Ford's 7.45 percent bonds due in 2031 fell to 22 cents on the dollar, down 4 cents, according to MarketAxess. GM's 8.25 percent bonds due in 2023 fell to 16.375 cents on the dollar, down 4.625 cents.

Ford and GM are the largest issuers in the high-yield market, according to Garman.

"As the auto executives are in front of Congress asking for funding, there's also a fairly dire outcome being priced into credit markets as well," he said.

Moody's Investors Service has projected that the U.S. junk bond default rate will rise to 11.2 percent by the end of October 2009 from 3.3 percent currently. A growing mass of very low-rated debt and extremely tight lending markets create considerable risk that defaults could be even higher, the rating agency said.

Still, the market has already priced in default rates of about 15 to 17 percent, according to Todd Youngberg, head of the high-yield team at Aviva Investors, a global asset manager with about $3.5 billion in high-yield debt under management.

Moreover, prices are now so low and yields so high that investors' downside is limited even if default rates got to Great Depression levels, he said.

"The risk return profile in the high yield market place is the best it's ever been historically, and I'm not sure you can say the same for a lot of the equity markets," said Youngberg, based in Chicago.

Junk bonds also typically begin recovering before a default wave is over. The market returned 39 percent in 1991 even as defaults were rising.

(Editing by Leslie Adler)