By Shannon D. Harrington and Abigail Moses Jan. 27 (Bloomberg) -- Traders are buying protection against defaults on sovereign debt at more than five times the rate of company bonds as governments fund ballooning deficits. The net amount of credit-default swaps outstanding on 54 governments from Japan to Italy jumped 14.2 percent since Oct. 9, compared with 2.6 percent for all other contracts, according to Depository Trust & Clearing Corp. data. European countries led the jump, with the amount of protection on Portugal climbing 23 percent, Spain 16 percent and Greece 5 percent. Rising use of derivatives to insure against defaults or speculate on government bond prices is spilling over into the corporate debt market, stemming a rally that drove yields to the lowest relative to sovereign benchmarks since December 2007, according to BNP Paribas SA. The global financial system remains “fragile,” with sovereign debt posing a risk to markets, the Washington-based International Monetary Fund said yesterday in its Global Financial Stability Report. The perception of rising risk “can puncture a country’s ability to access the capital markets,” said Scott MacDonald, head of credit and economics research at Stamford, Connecticut- based Aladdin Capital Management LLC, which oversees $11.9 billion. “Maybe it’s not an end-all be-all indicator. But when these countries get into a position where they need to raise capital, it becomes a confidence game,” he said. Elsewhere in credit markets, the extra yield investors demand to own corporate bonds instead of Treasuries held at 164 basis points, or 1.64 percentage points, yesterday, Bank of America Merrill Lynch’s Global Broad Market Corporate Index showed. The spread has widened from this year’s low of 160 basis points on Jan. 14. Losing Streak Spreads on high-yield securities increased for the sixth day yesterday, the longest period since August. The gap on junk bonds widened to an average of 644 basis points from 642 basis points on Jan. 25 and the low this year of 599 basis points on Jan. 11, according to the Bank of America U.S. High Yield Master II index. The market for mortgage-backed and asset-backed securities shows signs of improving. Lloyds Banking Group Plc is selling $2.4 billion of bonds in euros, pounds and dollars in Europe’s first issue of mortgage-backed debt aimed partly at U.S. investors since credit markets began to seize up in 2007. Ford Motor Co.’s finance unit plans to offer $1 billion of bonds backed by auto leases, according to a person familiar with the offering who declined to be identified because the terms aren’t set. Yesterday, Discover Financial Services sold $750 million of bonds backed by credit-card payments, boosting the sale from $500 million. ‘Increase of Risk’ Unprecedented fiscal and monetary stimulus programs have “come at the cost of significant increase of risk to sovereign balance sheets and a consequent increase in sovereign debt burdens that raise risks for financial stability in the future,” the IMF said in the report. The Markit iTraxx SovX Western Europe Index, which measures the cost of credit-default swap protection on the debt of 15 governments from Germany to Greece, rose 5 basis points to 83, according to CMA DataVision prices. That means it costs $83,000 a year to insure against losses on $10 million of debt for five years. Default swaps tied to Greece’s sovereign debt have more than doubled to 345.5 basis points since Sept. 30 as the government struggles to reduce a budget deficit that’s 12.7 percent of gross domestic product, CMA DataVision prices show. Greek Bond Sale Greece sold 8 billion euros ($11.3 billion) of bonds this week at a premium to yields on outstanding securities in the first issue since the country was downgraded last month by Standard & Poor’s, Moody’s Investors Service and Fitch Ratings. The net notional amount of credit swaps on Greece has increased to $8.8 billion, according to DTCC data. Contracts on Portugal bonds have jumped to $9.6 billion since October 9, the data show, as the nation faces a budget shortfall that’s more than twice the European Union’s limit. The cost of protection on Portugal has more than doubled since September to 138 basis points, according to CMA. Bets on Italy have jumped 13 percent to $25.4 billion, while the net amount of swaps on Spain climbed 16 percent to $15.2 billion. Traders “are not necessarily betting there’s a default,” said Brian Yelvington, head of fixed-income strategy at Greenwich, Connecticut-based broker-dealer Knight Libertas LLC. “But rather that the credit risk profiles differ enough that they certainly shouldn’t trade right on top of each other.” Credit swaps on Spain have jumped to 83 basis points more than Germany, from 31 basis points on Sept. 30, CMA data show. Governments, Corporates The surge in trading of sovereign debt swaps comes as the cost to protect against losses on government debt exceeds that of companies in some cases. Swaps on almost a third of the 125 companies in the benchmark Markit iTraxx Europe Index are trading for less than the governments of the countries where they’re based, BNP analyst Andrea Cicione in London said in a report last week. In the U.S., swaps on 8 companies in the Markit CDX North America Investment Grade Index were quoted for less than contracts on Treasuries, according to CMA data. The cost of protecting against losses on European corporate bonds rose today, with the high-yield Markit iTraxx Crossover Index of default swaps climbing 13 basis points to 452, near the highest level in five weeks, according to JPMorgan Chase & Co. prices. The Markit iTraxx Japan index fell 4 basis points to 138, BNP Paribas prices show, the biggest drop since Jan. 7. Lloyds Mortgage Bonds Lloyds, the U.K.’s biggest provider of home loans, is offering the first dollar-denominated mortgage bonds backed by European assets since July 2007, Deutsche Bank AG data show. Britain’s mortgage-backed bond market shut in 2007 when securities linked to U.S. subprime loans slumped, causing investors to shun hard-to-value assets. A portion of top-rated AAA rated notes in dollars with an average life of 2.95 years may yield about 115 basis points more than the London interbank offered rate, or Libor, said three people with knowledge of the deal who declined to be identified before the transaction is completed. The bonds, backed by prime U.K. mortgages, will be issued by Lloyds’s Permanent Master Issuer Plc, the people said. Rising Prices Lloyds, 43 percent-owned by U.K. taxpayers, is tapping dollar-based investors as prices on U.S. mortgage securities increase from record lows. The most-senior notes backed by U.S. option adjustable-rate mortgages traded last week at about 54 cents on the dollar from 33 cents in March, Barclays Capital Inc. data show. Ford’s sale of asset-backed bonds comes three weeks after the Dearborn, Michigan-based automaker’s finance unit issued $1.25 billion of so-called floorplan bonds, which are linked to loans that finance cars on dealer lots. Nissan Motor Co. plans to offer $500 million of bonds backed by payments from dealers, according to a person familiar with the offering. The top-rated debt is eligible for the Federal Reserve’s Term Asset-Backed Securities Loan Facility, said the person. U.S. junk bonds have returned 1.41 percent on average this month, compared with 1.79 percent for investment-grade company debt, Bank of America indexes show. Junk bonds are rated below Baa3 by Moody’s and less than BBB- by S&P. Junk bonds weakened yesterday even as reports in the U.S. showed home prices and consumer confidence both climbed. The S&P/Case-Shiller home-price index increased 0.2 percent in November and the Conference Board’s confidence gauge rose this month to the highest level in more than a year. The U.S. Federal Open Market Committee is likely to keep its target interest rate for lending between banks unchanged in a statement at about 2:15 p.m. today, after completing its two- day policy meeting. The Fed probably won’t raise rates from its range of zero to 0.25 percent target until November, according to the median of 51 forecasts in a Bloomberg survey of economists. To contact the reporters on this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net; Abigail Moses in London at Amoses5@bloomberg.net

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