As impressive, as disappointing or as middling as you might have found the deals from Gazprom and Fiat last week, you almost certainly would not have thought of them as surprising. After all, the corporate bond market has been creeping down the credit spectrum over the last six months. There have been no sharp changes, just a succession of small steps — the odd unrated issuer here, and the occasional split-rated deal there — as investors have grown in confidence. High grade accounts have steadily eased away from the double-A rated only mindset of the beginning of the year, and last week’s deals from emerging market and high yield issuers were simply the next natural step.
But cast your net back a little further, and the distance travelled by the market is staggering. Only six months ago, many investors would not have dreamed of looking at anything outside the safe and stable telecoms or utility sectors or below a solid double-A rating. And it is less than two months since investors wet their appetite for high yield deals when Pernod Ricard issued the first benchmark sized transaction in nearly two years.
For most of the year it was laughable to think that Fiat and Gazprom could get deals away at all. The prospect that Fiat would build a book of Eu10bn with orders from more than 600 accounts with Gazprom’s books not far off, or that both deals would mainly attract mainstream, high grade investors, was even more remote.
But now these deals are accepted as the natural next step of the rally. So what has happened to change high grade credit investors’ attitudes so much in only a few months?
At the beginning of the year, a huge amount of investor cash moved into the corporate bond market. The asset class offered a better risk-reward profile than equities or cash deposits, even well-rated credits were offering bonds with tempting returns and there was plenty of pent-up cash to put to work. Daimler International (rated A3/A-) put out five year paper in the first quarter of 2009 with a coupon of 9% and Volvo Treasury (Baa1/A-) issued the same maturity but at 9.875%.
The market has come a long way since the first quarter. Over the last few weeks, prices have tightened almost as quickly as borrowers can issue paper, and investors are not getting the returns they once were for the highest grade deals.
But having become accustomed to high single digit coupons, investment grade accounts are looking at high-yield names like Fiat (which offered a yield of 9.25% for its three year paper) or emerging market credits such as Gazprom (which sold its six year deal to yield 8.12%).
After investment grade corporate bonds had their season in the sun over the first half of the year, it now looks like investors’ attention will turn to the high yield and emerging markets sectors, and that these will be the hot spots for issuance over the coming months.
And why not? High grade issuance volumes are likely to drop off in the later months of the year, particularly if banks begin to lend more again, but investors still have plenty of cash to put to work, helped in no small way by the continued absence of previously competing sectors — structured finance redemptions alone are topping tens of billions each month.
Although investors aren’t yet willing to swallow just any issuer for the sake of yield, their focus is certainly shifting. For the rest of the year, a further move to high yield and emerging market deals is likely to be the next step for corporate bond investors.