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2022, the summer of credit opportunities?

Henry's Cafe Bar - West India Quay - Canary Wharf - London

An unusually busy period for investors could beckon unexpected opportunities for the battered FIG market

This year has shaken the valuation of financial assets, so much that the first half of 2022 has been classified by some as the worst year on record for bonds. Naturally, it is easy to see why debt capital markets participants have been desperately longing for holidays, but the summer of 2022 may also turn out to be the summer of opportunities, for both bond investors and issuers.

There are so many factors driving volatility: from inflation in the US and Europe, supply bottlenecks, Chinese Covid lockdowns, to recession fears and the war in Ukraine.

That meant the first half year finished with dismal results. Government and investment grade bonds lost 15.4% and 15.8% respectively, while stocks dropped 19.1%, according to Bank of America research.

One syndicate desk in Europe neatly summarised the grim picture — the S&P 500 index had its worst first half year since 1970, the two year US Treasury yield had had its largest jump since 1984, driven by the 125bp rate hike from the Federal Reserve — the biggest rate spike since 1994 — resulting in “the largest best-to-worst sector performance ever.”

And the 40 year high inflation in the US is yet to peak.

It is not surprising that July's BofA global fund manager survey showed “full capitulation”, and the bank’s Bull & Bear indicator remained at “max bearish” of zero.

Joyeux quatorze juillet

However, one market seems to be weathering the storm.

Typically, the European primary bond market significantly slows down after Bastille Day (July 14) in France with scant new issuance across sectors. That thinking, it appears, should be disregarded for the unusual summer of '22.

The European Central Bank is yet to begin its rate hiking cycle. Central banks, seemingly falling behind the inflationary curve, are only adding to myriad other uncertainties for the second half of the year.

What this points to, is a situation where many bond and credit market participants cannot afford to leave their desks for too long. No respectable investor should leave an understaffed bond desk ahead of the ECB meeting later this week, or the FOMC at the end of July.

“It’s not the market in which you can disappear for two weeks — everyone has to stick around a phone or a computer," are the words of one London debt syndicate banker. "When you come back you could be facing a completely different world.” The banker echoes a large chunk of the credit market, tired for summer respite, but glued to screens afraid that a sudden volatility can swiftly swiftly reprice markets, again.

Economic readings and inflation reports will be keenly observed. For this year, at least volatility is not over just because summer has arrived in Europe.

The odds of a 50bp hike from the ECB have increased this week compared to early indications of a likely 25bp lift off. Even if the central bank delivers a 25bp rate spike there would likely be a reaction, as even the Bank of England is now flagging a 50bp rate hike as possibility for its August meeting.

Moreover, the European central bank is also expected to introduce its anti-fragmentation tool amid growing political instability in the eurozone and rising discussions — whether justified or not — that a sovereign debt crisis may soon start brewing.

The Bank of Japan meets on July 21. This may not offer any big changes, but this is the only major central bank left firmly stuck to easy monetary policy. That has pushed the yen as the currency of choice for the carry trade. It is not a meeting to miss before market players get their confirmation that the BoJ will remain committed to its yield curve control, at least for now.

And then there is the FOMC meeting on July 27, which until last week had sparked speculations of a 100bp hike and led wild market swings.

These market moving dates can only suggest investors will likely have decently staffed desks, at least until the first week of August.

Keen FIG issuers

And if investors are there, why should issuers not be there too? Issuers can, and should, take advantage of investors’ presence in the hot summer of 2022.

Some debt capital markets and syndicate bankers in the European FIG market have suggested that the ECB’s anti-fragmentation tool could even spur primary issuance in the single currency.

If the ECB’s meeting results in a market positive reaction, some bankers have said they would recommend FIG borrowers to issue in the last week of July and the first week of August.

After the first half year finished with banks’ euro senior bonds returning negative 9.5%, pushing senior spread to the widest levels this year, the European FIG market very much needs a shot in the arm, however that may materialise.

It is no wonder that at least a handful of bank and insurance subordinated, capital deals have been pushed back to autumn.

Bankers, even those in France — known for its month-long summer holiday — are now saying issuers should be nimble and look at printing whenever a market window opens.

As September is expected to be jam-packed in the European FIG market, this could result in issuers competing for investor attention in autumn. Some say that this could mean issuers start to monitor the primary market as early as mid-August.

Indeed, the expected handful of “opportunistic” deals could be the opportunity that the battered European FIG issuers need to meet their funding targets.

Issuers will be there, looking for any opportunity, and investors will be following any signs of volatility. It would appear that this year's summer lull will be short lived.

Primary revival

No doubt there is a lot of uncertainty ahead for both FIG issuers and investors in the sector, but most bankers in Europe appeared quite certain — until the end of last week at least — that there was going to be very limited primary FIG action this week, bar potential post-earnings deals from US banks. Yet, this has not been the case.

Nobody active in the covered bond market has been able to pin-point why a roaring demand for the product has now materialised, in what was supposed to be a quieter time for the asset class.

That was until this Monday, when LBBW succeeded in attracting €4.7bn of demand for its €1bn 5.6 year deal. While it attained its largest ever order book for a covered bond, it also halved the new issue concession it had to pay for its covered funding.

Judging by LBBW’s trade, which tightening by 4bp within less than 24 hours after pricing erasing all the new issue concession, there is scope for performance.

Seeing this result, Deutsche Pfandbriefbank appeared a day later, pushing forward its autumn covered bond funding, to raise €750m from a March 2027 deal. It also halved the new issue premium it had to pay.

It may well just be demand from German issuers, but German borrowers were also supposed to be on a summer hiatus and deemed unlikely to print or buy big chunks of new debt.

More covered bonds are expected, and not only from Germany. There is market chatter that a French issuer is also eyeing the market, and may print as soon as this week.

It can be argued that this phenomenon is specific to the covered bond market, where spread widening is largely expected to be contained, rather than the entire FIG space. However, banks also need senior funding and regulatory capital.

Meanwhile, all that market chat that the credit markets are presenting great entry points for investors could as well be manifesting in those issuers that are printing senior debt now.

Aiming to meet its senior funding target, Aareal Bank opted to issue now instead of the autumn, and printed a €500m three year senior preferred green bond on Tuesday at a spread of mid-swaps plus 300bp.

Before that, On July 12, Nova Ljubljanska Banka, Slovenia’s national champion, issued a €300m three year non-call two senior preferred bond at 6%.

After all, having hit the bottom of the sentiment indicator, July’s global fund manager survey from BofA says that despite the “fundamentals [being] poor, stocks/credit rally [is expected] in coming weeks.”

And who would want to miss any kind of a potential rally of any sort after the dismal start to the year?

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