Should you buy BP bonds?

Yields for BP bonds have gone sky-high. Are bonds a smart buy?

By Kim Peterson Jun 16, 2010 3:07PM
Fitch has downgraded BP (BP) by six notches. Yeah, you read that right: BP is almost at junk status.

Investors responded Tuesday by unloading BP bonds, sending yield soaring. The yield for one bond that matures in 2013 rose to 8.7%, The Wall Street Journal reported. Another bond that matures next year is getting an 8.5% yield.

That sounds awfully attractive. But before you consider bonds, you need to think about another "b" word: Bankruptcy. That's the real danger to BP bond holders, the Journal reports.

What are the chances that BP will head into bankruptcy? One money manager pegged it at 30%, according to the Journal. Of course, that was before news emerged that BP agreed to a $20 billion fund for claims related to the oil spill.

BP shares are trading at around $31 -- nearly half of what they were at in April. Post continues after video:
One analyst told the Journal that while BP stock might be tempting, the more conservative bonds are a better buy at this point. (Another knock against the shares would be BP's decision Wednesday to suspend its $10 billion dividend.)

Even Fitch doesn't anticipate a BP bankruptcy. But the firm downgraded the energy giant for two main reasons, the Journal reported. First, government scientists suspect a much higher spill rate than BP had claimed -- which could lead to finds from the Justice Department. Second, the burden of that $20 billion escrow fund on BP's bottom line.

But there are some that do expect a BP bankruptcy. Credit investors are giving BP a 39% chance of defaulting in five years, Bloomberg reported. That was calculated by looking at BP credit-default swaps, which are sky high at this point.
BP may be able to avoid bankruptcy by sacrificing its BP Holdings North America unit, the New York Times reports. BP is actually made of up lots of smaller corporate entities, each with its own limited liability.

BP's North American unit has about $50 billion in assets, the Times reported, and BP could argue that those assets are the extent of its liability related to the oil spill.

"A more remote prospect is the insolvency of BP itself," writes Steven Davidoff. "I say this is remote because of the liability issues above and the fact that BP has $161 billion in long-term assets, providing it a big cushion."

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