Flagging debt markets perk up

LONDON (CNNMoney.com) -- Pockets of the debt markets are showing signs of life, raising hopes that the worst of the credit crisis is over.

"We've got a market that is more functional," said Tony Crescenzi, chief bond market strategist at Miller Tabak & Co.

In the corporate debt market, healthy companies issued bonds at a slower pace in the third quarter, but the slowdown was much less dramatic than in other areas rocked by panic this summer.

And the Federal Reserve's latest figures show that the commercial paper market, which companies and banks rely on for short-term financing, has started to loosen after locking up in August.

The improving conditions in both markets show that despite tighter lending among banks, companies are finding ways to raise money to run their businesses.

But in the wake of the summer crisis, a sense of uncertainty lingers. Purchasers of debt, worried about the state of the economy and whether companies may have trouble repaying, are demanding higher rates.

To be sure, the investment-grade sector has benefited from the recent flight to quality sparked by the subprime meltdown. Companies that are rated investment grade have a higher probability of paying back their debt than those that are rated junk, or high yield.

"There's still a huge amount of cash looking for a home. The investment-grade sector provides a nice investment, especially with the unease in the high-yield sector," Kim Rupert, fixed-income analyst at Action Economics.

The amount of high-grade corporate debt issued in the first nine months of the year rose to $772 billion, up 10.3 percent from the same period in 2006, according to Thomson Financial. The figure is on track this year to top $1 trillion for the first time ever.

While quality companies are selling debt in record amounts, investors are proceeding with caution and demanding higher rates for putting their money at risk.

Recent yield spreads of long-term industrial company bonds have measured 141 basis points for single-A rated debt, above the long-term average of 126 points, according to John Lonski, who tracks global credit markets for Moody's Investors Service.

Fear of more credit turbulence may explain why spreads over Treasurys are wider than usual. Wider spreads give investors "more protection in the event that there is another credit shock," Lonski said.

As the dust settles, the credit markets are still far from a full recovery. Some parts, such as the market for risky loans, aren't expected to return to levels seen during their boom days.

Some high-profile leveraged loans have been sold to investors. Last month, banks sold nearly double the $5 billion in loans they had originally planned to finance the buyout of First Data Corp.

But this part of the market remains far below the levels scaled in recent years. In the third quarter, leveraged loan volume sank 64 percent to a two-year quarterly low of $68 billion, according to Standard & Poor's Leveraged Commentary & Data.

Elsewhere, debt investors are being more careful about what they're buying. They are waiting to see whether the economy deteriorates and companies start struggling to repay debt on time, Crescenzi said.

"At the end of the day, what bond investors care about is getting their money back," he said.