American credit market outlook

TXU Corp has taken a licking in the corporate bond market recently as investors have fret over the company's share buybacks, and while the worst might be over, the pummelling may not be done. TXU on Thursday posted first-quarter earnings more than twice those of a year ago, but also announced its intention to buy another 6 million shares. The company said it will take on more debt to fund the buybacks. TXU had about $11.7 billion of debt outstanding as of March 31, a level that could rise to $12 billion, Standard & Poor's said. TXU seems to be taking a more aggressively shareholder friendly policy, both Fitch and S&P said, which is not positive for its credit quality.
For its part the company says its financial performance is improving. "The fundamental message in our earnings statement is that all our metrics are showing improvement. There's a bigger story here," a spokesman for TXU said.
Although the power company's cash flow is rising, it may not stay high if natural gas prices decline, S&P said in a statement. Gas prices help determine power prices in Texas, which in turn have a direct impact on TXU's revenues, profits, and cash flow.
But TXU's credit is facing other challenges as well. Investors now are leery of non-investment grade credits, and TXU is becoming increasingly junk-like. Moody's Investors Service already rates the company's debt at sub-investment grade levels. "For a credit like this, you have serious technical and fundamental considerations," said Bryan Higgins, electric utility credit analyst at 4086 Advisors in Carmel, Indiana.
S&P said on Friday it may cut the company's debt ratings to junk in the months ahead, while Fitch changed TXU's outlook to negative, signalling a cut to junk is possible longer term.
The speculative-grade bond market has grown dramatically since Thursday, after S&P cut major bond issuers Ford Motor Co and General Motors Corp to speculative grade. Prices in the market have dropped, and investors are unsure where levels will stabilise.
The cost of protecting TXU debt against default for five years has surged this week, to around 165 basis points on Friday from around 100 basis points on Monday. At current levels, protecting $10 million of debt against default for five years costs $165,000 a year.
That level could widen a little more on Monday after the market digests the S&P rating action on TXU, which took place late on Friday, a trader and an analyst said. The analyst's company was short TXU's credit.
But much of the widening in the credit has likely already taken place, judging by credit levels for other utilities with at least one junk rating, the trader said.