Debt sales push U.S. corporate bond risk to new highs

By Dena Aubin

NEW YORK (Reuters) - U.S. corporate bond yields have surged back to record levels relative to Treasuries after Citigroup and other financial firms sold a flurry of high-coupon debt last week, pressuring yields upward in the broader market.

The higher yields investors demand to buy corporate bonds are the latest sign that credit strains persist despite Federal Reserve moves to calm financial markets.

Average investment-grade bond yields hit 3.05 percentage points over Treasuries on Friday, according to Merrill Lynch data, matching a record high hit on March 20 after the collapse of investment bank Bear Stearns.

"The momentum behind the move came from the financials index," fixed-income research service CreditSights said in a report on Saturday. Yields on financial companies' bonds rose by 9 basis points last week to 370 basis points over Treasuries, even higher than after Bear Stearns' collapse.

Persistently high borrowing costs for banks could further curb their ability to lend, worsen a cash crunch at the sickest companies and extend an economic slump.

"We're still waiting to see some numbers that show these banks are stabilizing and recovering," said Dan Sheppard, director at Deutsche Bank Private Wealth Management.

Citigroup (C.N) last week had to offer yields of over 6.5 percent, or 3.375 percentage points more than Treasuries, to entice investors to buy $3 billion of five-year notes.

In April, Citigroup sold $4.5 billion of five-year notes at a 5.6 percent yield, or 3 percentage points over Treasuries. Since then, deteriorating capital markets and a slumping economy have triggered massive write-downs at the bank. On July 18, it posted a $2.5 billion second-quarter loss, smaller than the market expected, amid $11.7 billion of write-downs and losses.

Citigroup and other global banks have absorbed more than $400 billion of write-downs and losses as a result of the global credit crisis.

Adding to concerns, banks have been charged with misleading investors about the risk of auction-rate securities and are having to buy back billions of dollars of the debt and pay fines to settle the charges.

"That takes up room on the balance sheet," said Deutsche Bank's Sheppard. "So far, it's only been for retail (small investor) accounts, but can the others be far behind?"

American International Group (AIG.N) last week paid an 8.25 percent yield, a level more common on junk bonds, to sell $3.25 billion of 10-year notes. AIG is rated in the double-A range.

"Increased new issuance is expected in the upcoming months, reducing demand for bonds in the secondary market," JPMorgan analyst Eric Beinstein said in a report on Friday.

Funding costs on new issues are pushing bond spreads wider, compared with credit default swaps, he said.

A government rescue plan last month for mortgage giants Freddie Mac (FRE.N) and Fannie Mae (FNM.N) eased investor fears for a while, but the positive mood reversed amid more write-downs and analyst downgrades of financial firms.