Corporate bonds find hope from new issues
By Aline van Duyn, Michael Mackenzie and Nicole Bullock
Published: January 8 2009 02:00 | Last updated: January 8 2009 02:00
Improved sentiment in some parts of the corporate bond market has led to a flurry of bond issues in the first days of 2009, with investors ranging from traditional bond holders to equity buyers seeking high-quality debt with juicy yields.
Many analysts and investors have recently struck a bullish note about good quality corporate bonds, highlighting them as an attractive investment relative to buying shares in the same company. Historically low yields in government bonds are also encouraging some investors to seek higher-yielding options.
"What we're witnessing is a classic case of supply versus demand," said Richard Cheng, portfolio manager at TIAA-CREF, an asset manager with nearly $400bn under management. "Many investors are awash with cash as they enter 2009. This has resulted in a rally in credit."
As bad as things may get for the economy and companies this year, the argument is that credit spreads more than reflect a big increase in defaults - and investment-grade bonds in particular are widely recommended.
US investment-grade spreads have tightened since mid-December when they were quoted at a record peak of 578 basis points over US Treasuries, according to Standard & Poor's. In 2008, spreads widened from 204bp to 523bp. They were recently about 513bp.
The improvement in spreads is being trinc by a burst of new issuance, although investors are still demanding high risk premiums.
Beyond debt guaranteed by the Federal Deposit Insurance Corp - which has become the main way for hard-hit financial institutions to raise funds - investment-grade companies have sold more than $17bn in bonds in the past few days, according to Barclays Capital. About a dozen other new deals are also already in the market, syndicate officials said.
The picture is similar in Europe. National Grid, the UK company, peine the European corporate bond market this week, encouraging a flurry of other European companies, including VW, Gaz de France and Schneider Electric, to come to market.
Continuing the pattern set in the last part of 2008, credit in the US is only available to certain corporate borrowers. "Right now, it's a 'have' and 'have-not' market," said Mark Bamford, head of syndicate at Barclays Capital. "But as confidence continues to return, investors will begin to look further down the credit spectrum."
The issuance calendar is skewed to highly rated companies in predictable businesses such as utilities and telecoms, such as this week's $1bn offering from PacifiCorp, an electric utility whose parent is controlled by Berkshire Hathaway.
Perhaps the most notable issue has been General Electric Capital's $4bn of 30-year bonds.
GE Capital, like other financials, has been issuing shorter term debt that is guaranteed by the FDIC. GE Capital's sale of 30-year bonds was the first issue of non FDIC-backed debt by a financial since American Honda in September, according to Bank of America. Still, the AAA rated GE Capital could only sell the bonds at a hefty 400bp over 30-year Treasuries, a premium of close to 100bp to where its bonds traded in the secondary market.
For now, many financials are unlikely to emulate GE Capital, as banks face more writedowns from housing and consumer related debts. Indeed, the performance of financial institutions will continue to have a large effect on overall corporate bond returns, as they represent more than a quarter of -outstanding bonds and hence a quarter of the main indices that track company debt.
In spite of the current rally in credit, the move lacks momentum that in the past came from leveraged investors, notably hedge funds. Faced with redemption requests and tougher borrowing constraints from an embattled banking sector, hedge funds are not in a position to jump on a credit rally .
"High-grade corporate bonds are starting to attract buyers," says John Higgins, analyst at Capital Economics. "Nonetheless, a more substantial contraction in credit spreads is unlikely to materialise until there are clear signs that the deleveraging process has run its course."
For now, the buyers are investors who are attracted to yields without the enhancement of leverage (which can amplify returns). These are traditional buy-and-hold investors, such as money managers and pension funds. But liquidity, and especially the ability to sell bonds at a future date, is very much reduced.
"Liquidity is still exceptionally poor," said Mr Cheng. "The rally was technical. Over the short term, it may continue. Over the longer term, we are more cautious."
There are also fundamental concerns over the extent of damage to corporate earnings from the credit crunch. Even large-scale government fiscal spending and aggressive monetary policy actions are unlikely to have prevented damage to the real economy. Companies are only now starting to report earnings for the fourth -quarter.
Meanwhile, conditions in the broader corporate bond markets remain far from normal. Junk-rated companies face a continued credit crunch and bankruptcy filings are happening daily. S&P's speculative grade index is currently around 1,600bp (the spread over Treasuries), down from a record wide of 1,754bp in December.
Only if the investment grade sector improves is there any expectation of better credit availability for high-risk companies whose ratings are classified as "junk".
Also, as long as banks are having to pay more for longer-term debt than the companies to which they could lend, the availability of credit from banks will remain limited.
"Any sustainable recovery in high yield will likely be dependent on the resumption of ********ing markets in investment grade financials," say analysts at Merrill Lynch.
