Corporate bonds – get your risk on
Rarely has the market looked so good while facing such a tempest
Europe’s high grade corporate bond market is primed for higher risk deals, with the negative to minimal concession EnBW paid for a dual tranche hybrid on Tuesday hinting at the swell of investor demand. Issuers from across the rating spectrum should take advantage before it is too late.
European Central Bank bond buying was around 20% higher than usual in July, according to JP Morgan estimates, though the ECB says this estimate is shaky. Nonetheless, so much of a central bank's effect on markets comes from the perception of its actions — just take the large equity sell-offs on the hint that the US Federal Reserve was considering tapering its asset purchases — so even anecdotal belief that the central bank was buying more is likely to have a positive impact on spreads, even if the reality is less supportive.
At the same time, primary issuance was at multi-year lows over the summer. This meant that corporate credit found itself more at the whim of technical factors than usual, with spreads kept low and steady, despite mounting reasons for the opposite to happen.
Investors have come back from their summer jollies looking for spread in any corner of the market where it might be hiding. This makes the market ripe for riskier trades, but the clock is ticking.
Issuers with hybrids coming due within 18 months should be considering an early refinancing to take advantage of what could be the best conditions for some time. It may feel overly cautious to refinance with that much maturity left in the tank, but recent history suggests it is worthwhile.
Last year’s hybrid supply bonanza saw corporates seek liquidity while protecting balance sheets and ratings in the face of plummeting revenue. Investors loved it, with syndicates deploying superlatives to describe negative new issue concessions and book sizes with abandon. The few difficult hybrid deals that did happen were from issuers who had, in part, left it late to refinance and were at the mercy of the market on the day.
It is not just subordinated debt that will benefit. Issuers that have been left bloodied and bruised by the coronavirus pandemic should also consider raising debt in this window. Airline travel is still a fraction of what it was pre-pandemic, as are hotel stays and trips to shopping centres.
The UK, US and China all posted worse than expected retail sales figures last week. Cash burn at airlines still runs into the tens of millions – budget airline Ryanair saw its shares surge in May when it said it had reduced its weekly cash burn from €200m to €60m.
Reverse Yankee issuance is another area that benefits from the hunger for spread, particularly for borrowers issuing from an entity not domiciled within the eurozone and outside of the ECB's Corporate Sector Purchase Programme.
So why the rush? There is no indication that ECB bond buying is going to slow down, and the central bank has indicated rates will remain low for years.
However, Europe’s corporate bond market has shown itself susceptible to what is happening in the US. The Jackson Hole symposium is this week, and analysts are growing increasingly vocal about the prospect for US Federal Reserve tapering to be flagged as soon as September.
Meanwhile, the high contagious delta variant of Covid-19 is becoming more prevalent in the UK, the US and across Europe. This raises the spectre not only of more lockdowns, and the economic damage that comes with that for bond issuers, but more disruption to supply chains, which fixed income analysts and investors have highlighted as a major source of concern.
Downside risks are stacking up. It’s time for corporate issuers to be bold.