American credit market outlook

By some measures, CenturyTel Inc's credit looks a little overpriced, but investors betting that its credit spreads will worsen have been and could continue to be wrong for a long time. There are risks linked to the credit. Investors are concerned that management will be tempted to take shareholder-friendly moves like buying back more shares or boosting dividends to bolster the company's stock price. CenturyTel shares have risen just 13 percent since the beginning of 2003, significantly lagging the Standard & Poor's 500 index's 37 percent rise.
Fellow rural telecom company Citizens Communications Co remedied its lagging share price by boosting dividends and accepting junk status, which makes CenturyTel's following suit seem more likely.
But the company recently announced a $200 million share buyback program, which had little impact on its bond spreads. There are no near-term plans to change the company's dividend policy, said Tony Davis, vice president in investor relations at CenturyTel in Monroe, Louisiana.
There are other risks for the credit, too. In coming years, the payments and subsidies that rural telecom carriers receive for serving sparsely populated areas are likely to change, which could result in lower revenues. But that could take at least 12 to 18 months to play out, which is a long time to wait for a credit to deteriorate, two analysts said.
With so many investors having bought protection, any slightly positive news could spur a big bout of short-covering, one trader said.
Add it all up, and CenturyTel is likely to perform in line with the market, the trader said.
Protecting CenturyTel debt against default for five years costs about 62 basis points, or $62,000 a year for every $10 million of debt insured in the credit derivatives market.
One portfolio manager suggested buying five-year protection on CenturyTel and selling protection on Citizens. That trade will perform well if the two companies' spreads converge, which could happen if CenturyTel boosts its dividends, he said.
Five-year Citizens protection costs about 134 basis points, so an investor putting on the position can earn a decent return just from the difference between the cost of the CenturyTel protection and the proceeds from selling protection on Citizens.
But the trade could perform poorly if telecom spreads broadly widen and investors move into higher quality credits, because Citizens' could suffer much more in that scenario. Broad spread widening seems entirely possible after January's jitters in the junk bond market.