Prices of high-yield loans in europe hit a two-year high as the improving outlook for corporate defaults and the economy open up financing for leveraged buyouts.

The average price for actively traded so-called leveraged loans climbed 7 basis points to 96.07 percent of face value since Jan. 1, according to Standard & Poor’s Leveraged Commentary & Data. The price of the debt, mostly used to finance mergers and acquisitions, reached the highest level since Dec. 13, 2007. A year ago, loans traded at 60.4 percent of face value.

Demand for riskier assets is returning as Moody’s investors Service forecasts that the default rate among speculative-grade companies will drop to 3.3 percent this year from 12.5 percent now. London-based private-equity firm apax partners LLP is raising 315 million pounds ($517 million) to finance its acquisition of Marken Ltd. in the first European LBO this year, according to data compiled by bloomberg.

“Investors are now looking at leveraged loans as a product offering attractive yields with limited downside,” said Edward Eyerman, head of leveraged finance at Fitch Ratings in London.

Elsewhere in credit markets, the extra yield investors demand to own European investment-grade corporate bonds rather than government debt increased 1 basis point to 152, near the lowest level since February 2008, according to bank of america Merrill Lynch index data. The spread on the European high-yield index narrowed 1 basis point to 699. A basis point is 0.01 percentage point.

Spreads Narrow

Spreads on investment-grade debt will narrow 20 basis points over the “near term” from 125 basis points now because of government measures to combat the credit crisis, Moody’s said yesterday in a report. Bonds rated below Baa3 by Moody’s and BBB- by Standard & Poor’s are considered below investment grade.

Credit Suisse Group AG, Switzerland’s biggest bank by market value, sold 2.25 billion euros ($3.24 billion) of seven- year notes yesterday in its first deal in the currency since Dec. 2, according to data compiled by bloomberg. The 3.875 percent securities due in seven years were the only European benchmark corporate notes yesterday, a U.S. holiday, compared with a daily average of 5.3 billion euros.

Slovenia sold 1.5 billion euros of 10-year bonds, joining governments from Mexico to Indonesia in the busiest start to a year for developing-nation foreign borrowing in a decade. Officials from Vietnam are meeting with investors in London today to market a $1 billion offering of 10-year notes. Albania plans to sell its first international bonds and is preparing to hire a bank to manage a sale of 300 million euros in three- or five-year notes, the finance ministry said.

Credit-Default Swaps

The cost of insuring against losses on European corporate bonds using credit-default swaps fell to near the lowest level in 19 months. The high-yield Markit iTraxx Crossover Index dropped 9 basis points to 404, according to jpmorgan Chase & Co. prices. The index is a benchmark for the cost of protecting bonds against default and a decline signals an improvement in perceptions of credit quality.

Credit-default swaps on Greek debt fell to 313 basis points from a record 344.5 on Jan. 14, according to CMA DataVision prices. European government officials met in Brussels yesterday to discuss Greece’s deteriorating finances.

Swaps on Iceland, whose economy buckled in October 2008 under $80 billion of debt at its three largest banks, rose 1.5 basis points to 545, CMA prices show. The nation’s credit risk may rise “considerably” should a proposed emergency bailout fail and its government collapse, S&P said yesterday.

‘Fragile’ Recovery

The Markit iTraxx SovX Western europe Index of default swaps on 15 European countries fell 3 basis points to 76 yesterday, after rising to a record 78.5 from 46 when it started trading in September, according to CMA. At the high point, it cost $78,500 a year to protect $10 million of debt from default for five years.

International Monetary Fund Managing Director Dominique Strauss-Kahn said yesterday it’s too early for policy makers to withdraw stimulus measures, describing the recovery as “fragile.”

Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.

Contracts on Northfield, Illinois-based Kraft Foods Inc. rose 1 basis point to 76.5, CMA said. The company is in talks to increase its bid for cadbury Plc to as much as 12.1 billion pounds, according to a person with knowledge of the matter. Swaps tied to bonds sold by Uxbridge, England-based cadbury climbed 5 basis points to 76.5, CMA prices show.

Leveraged Loans

Leveraged loans in europe will return between 7 percent and 9 percent this year, barclays Capital forecasts. investors have earned a 1.27 percent return on the debt this year, the London- based bank’s data show.

“A lot of companies refinanced their loans at par in the bond market so that drives returns,” said Axel Potthof, senior vice president of Allianz Global investors in Munich.

Lloyds Banking Group Plc is arranging the loan for Apax, according to a person familiar with the plans. Apax didn’t disclose the price for the U.K. vaccine courier when it agreed to buy Marken from Intermediate Capital Group Plc last month.

The loan includes 150 million pounds of six-year term loans that pay 4.5 percentage points more than benchmark rates, 150 million pounds of seven-year debt with a spread of 5 percentage points and a 15 million-pound, seven-year revolving credit with a 4.5 percentage-point spread, according to the person.

Fiona Mulcahy, a London-based external spokeswoman for Apax, declined to comment.

LBO Debt

When Apax bought a stake in U.K. publisher Trader Media Group Ltd. in 2007, it paid interest margins on loans of 2.25 percentage points, bloomberg data show. Marken’s debt equals four times its earnings before interest, tax, depreciation and amortization, the person said.

The LBO market, where buyers acquire companies using mostly debt financing, collapsed in 2007 when underwriters got stuck with $200 billion of loans they couldn’t sell as credit markets froze. Demand for higher-yielding securities is increasing again as Europe’s economy returns to growth.

The region will expand 1.4 percent in 2010, according to the median forecast of economists surveyed by bloomberg News. Growth resumed in the third quarter as governments stepped up spending and exports increased for the first time in 1 1/2 years, the European Union’s statistics office in Luxembourg said Dec. 3. Gross domestic product in the 16-nation euro region rose 0.4 percent from the second quarter, when it dropped 0.2 percent.

“If you’re a high-yield bond investor, you can buy another new bond, but if you are a loan investor, you don’t have that option, you will need to reinvest in the secondary market,” said Alex Moss, a fund manager at Insight Investment Management in London.