American credit market outlook

Even as the improving economy helps heal balance sheets and has many credit analysts talking of "rising stars," one camp of struggling companies is at risk of being slashed to junk quality.
Electronic Data Systems Corp, the second-largest US technology servicers provider, joined that notorious group on Friday.
Some credit default swap traders were already chomping at the bit, before EDS announced its earnings late on Thursday, to drive its spreads wider on any poor news.
EDS did not disappoint, posting a $354 million fourth-quarter loss on charges related to a still-problematic Navy contract.
The beleaguered company has already struggled with big-time competition and a government probe.
But the write-down on the Navy contract, which sliced a cool $1 billion of free cash flow between 2004 and 2007, suggested serious trouble.
Analyst Frank Lee at CreditSights wrote on Friday that he was sceptical the Navy contract "is free from problems, and that the company could further disappoint with lower free cash flow generation from this project over the next four years."
Making matters worse, EDS said 2004 profit would be only half of what was expected.
But as with some other companies, the threat of a junk rating for EDS has led several traders to take opposing positions in the default swap and cash corporate bond markets.
That is because some of the company's bonds will offer a 50-basis point increase in coupon with a junk rating by Standard & Poor's or Moody's Investors Service.
Some traders in the default swap market said that even though the company's prospects seem dour, the ratings agencies may back off from cutting EDS to speculative.
EDS' business is based on long-term contracts, and a junk rating is likely to make it extremely difficult for it to secure long-term contracts.
S&P put EDS' "BBB" rating on watch for a cut, though it still remains two-notches above junk. Moody's, however, already rates EDS at "Baa3," the edge of speculative, and put it under review for a slash.
The idea behind taking opposing positions in derivatives and cash bonds is that the bonds will benefit from the higher coupon from the special language if a cut to junk comes, traders said.
But the default swaps do not benefit from the bigger coupon, while the company's credit quality is deteriorating.
Thus traders and investors buy standard five-year default protection, which drives default swap spreads wider, but then turn around and buy the company's bonds with the step-up option, like those notes due in 2013.
The spread on EDS' five-year default swap pushed out to as wide as 230 basis points before trading around 220 basis points at the end of the session, or $220,000 a year for $10 million of default protection.
That is up about 25 percent from its levels around 175 basis points late Thursday.