By Pierre Paulden and Caroline Salas Feb. 2 (Bloomberg) -- President Barack Obama’s proposals to limit the size of U.S. banks helped wipe out $430 billion of financial companies’ stock market value and also made their bonds irresistible to some of the nation’s biggest investors. Banks in the MSCI World Index fell 5.1 percent while the extra yield investors demand to own their bonds instead of Treasuries widened to 238 basis points yesterday from a low of 224 basis points, or 2.24 percentage points, on Jan. 12, according to the Bank of America Merrill Lynch U.S. Corporates, Banks Index. That compares with a median spread of 119 basis points during the last five years. Now, TCW Group Inc., AllianceBernstein LP and Advantus Capital Management say bank bonds are attractive. The government won’t tolerate another failure like the bankruptcy of Lehman Brothers Holdings Inc. in September 2008, which led to a seizure in credit markets, investors said. “It’s understood now that decisions such as letting Lehman Brothers file for bankruptcy are so dangerous and detrimental to an economy,” said Tad Rivelle, chief investment officer for Metropolitan West Asset Management LLC and a manager of TCW funds, where he helps oversee $55 billion. He’s buying senior and subordinated debt securities of the largest financial firms because a failure is “unlikely to be repeated.” Elsewhere in credit markets, the yield spread on company bonds overall expanded 2 basis points yesterday to 166 basis points, 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. The average yield ended yesterday at 4.1 percent. P&G Bonds The cost to protect bonds of North American companies from default fell for the first time in four days. Consumer products company Procter & Gamble Co. sold $1.25 billion of notes at a bigger spread than its last offering. Bonds of movie-rental chain Blockbuster Inc. fell for the fifth time in eight days. Fewer banks demanded stricter standards for loans to consumers and companies last quarter, a Federal Reserve report showed, as the economy grew at the fastest pace in six years. Banks continued to tighten the terms of loans they did make, and demand for both business and household loans weakened over the past three months, the Fed said yesterday in its quarterly survey of senior loan officers. Obama asked Congress on Jan. 21 to limit the size of banks, curb proprietary trading and prohibit them from investing in hedge and private equity funds to prevent a repeat of the worst credit crisis since the Great Depression. While the rules would hurt shareholders by restricting growth, they may make the bonds more appealing by reducing the risks the firms are taking, said Tom Houghton, a vice president and portfolio manager at Advantus in St. Paul, Minnesota. ‘A Better Idea’ “I understand from the equity standpoint why you’d be concerned, because you’re taking some of the growth story off,” said Houghton, who manages $2 billion. “If you’re a creditor, you’d be less concerned about a Goldman Sachs or a Morgan Stanley. You’d have a better idea of what they’re doing.” Houghton is “overweight” bank bonds, meaning he owns a higher percentage than is contained in benchmark indexes. Banks deserve wider yield spreads because government involvement may increase volatility in the debt, said Marilyn Cohen, president of Envision Capital Management in Los Angeles, who manages $250 million in fixed-income assets. “Investors thought ‘Uh, oh, here they come again with their sticky fingers and who knows what else they’ll have up their sleeve,” she said. “Clearly this whole ‘Government is better and can do it much better’ idea isn’t going away.” Wider Spreads Citigroup Inc.’s $4 billion of 6.125 percent senior unsecured notes maturing in 2017 have fallen to 100.5 cents on the dollar to yield 6 percent, from 102 cents on Jan. 20, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The debt dropped 0.5 cent yesterday on speculation the New York-based lender will sell or split its $10 billion Citi Private Equity unit. Citigroup, 27 percent owned by the government following a bailout in 2008, is selling almost a third of its $1.86 trillion of assets under regulatory pressure to shrink, said people familiar with the matter, who declined to be identified because the sale talks are private. JPMorgan Chase & Co. analysts led by Eric Beinstein in New York said in a Jan. 29 report that banks are becoming more creditworthy and spreads will tighten. Morgan Stanley credit strategist Viktor Hjort in Hong Kong recommended on Jan. 25 that investors buy the bonds because lenders are increasingly profitable after selling shares to replenish capital eroded by the global financial crisis. Losses and Writedowns Financial institutions have raised $1.5 trillion to help cope with more than $1.7 trillion of losses and writedowns since the credit freeze began in 2007. The U.S. government has also backed debt and injected capital to prevent further failures. “Just as with 2009, it will be hard to outperform in credit without having exposure to financials,” said J.J. McKoan, head of global credit at AllianceBernstein in New York, who started buying financial securities early last year. The sector is the only one in investment-grade credit that trades at a “meaningful dispersion” to the benchmark index, he said. Credit-default swaps on the Markit CDX North America Investment-Grade Index Series 13, which is linked to 125 companies and used to speculate on creditworthiness or to hedge against losses, fell 2.5 basis points 94.5 basis points, according to broker Phoenix Partners Group. A drop in the index signals a rise in investor confidence. The drop came as the Institute for Supply Management said its manufacturing index expanded faster in January that economists forecast. Toyota Recall The Markit iTraxx Europe Index of 125 companies with investment-grade ratings was unchanged at 83 basis points, JPMorgan prices show. Swaps on Toyota Motor Corp. rose to the highest since July in Asia as the automaker recalled 2.3 million U.S. cars because of sticking accelerator pedals. The contracts surged about 12 basis points to 92 basis points, CMA DataVision prices show. Procter & Gamble’s 1.375 notes were priced to yield 55 basis points more than two-year Treasuries, Bloomberg data show. In August, Cincinnati-based P&G sold $1 billion of two-year notes at a spread of 38 basis points. The yield compares with 1.225 percent on 5.98 percent debt due in April 2012 sold by competitor Colgate-Palmolive Co. Both companies have similar ratings from Moody’s Investors Service and Standard & Poor’s. Proceeds will be used for refinancing, B. Craig Hutson, a bond analyst for Gimme Credit in Chicago, wrote in a research note yesterday. Blockbuster Falls Dallas-based Blockbuster’s $300 million of 9 percent notes due in 2012 fell 3.5 cents yesterday to 22.5 cents on the dollar, according to Trace. The securities tumbled from 61.875 cents on Jan. 20, when the company said its cash flow for the year ended Jan. 3 was lower than analyst estimates. In the market for asset-backed bonds, U.S. political and regulatory “uncertainty” contributed to higher yields on debt tied to hotel, shopping center and skyscraper loans relative to benchmarks, according to JPMorgan analysts led by Alan Todd in New York. The spread on top-ranked commercial-mortgage backed securities increased 0.3 percentage point to 4.8 percentage points more than a benchmark swap rate last week, JPMorgan data show. To contact the reporters on this story: Pierre Paulden in New York at ppaulden@bloomberg.net; Caroline Salas in New York at csalas1@bloomberg.net

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