U.S. distressed debt, among the hardest hit asset classes last year, has become the best, with returns of 39.5 percent year to date as risk appetite improves, Bank of America Merrill Lynch said.

For the month of May, distressed debt was second only to emerging market equities after returning 25.4 percent, Bank of America Merrill said in a research note late on Monday.

Distressed issuers are those whose bond spreads trade at or above 1,000 basis points over comparable Treasuries.

Distressed issuers drove 95 percent of the strong performance of the U S. high-yield corporate bond market in May as a resurgence of new debt sales improved sentiment, the report said.

Some deeply distressed issuers were able to access new issue markets and enjoyed significant improvements in pricing of their existing bonds as a result, said Oleg Melentyev, lead author of the report.

Companies including Ford Motor Co's finance arm, Harrah's Entertainment and MGM Mirage sold more than $23 billion in junk bonds in May, the most since the credit crisis started in mid-2007, according to Thomson Reuters data.

The high-yield cash market outperformed high-yield derivatives by 2 percentage points in May, the report said. The main index of high-yield credit default swaps returned 5.1 percent while Merrill Lynch's high-yield Master II index returned 7.1 percent.

The junk bond market has retraced all of the losses it sustained in the financial meltdown late last year, Melentyev said.

(Reporting by Tom Ryan; Additional reporting by Dena Aubin; Editing by James Dalgleish)

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