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A credit paradox: ratings are ignored — and feared

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By Jon Hay
08 Apr 2020

For many years, corporate debt investors have scratched their heads and wondered: will anything, ever, cause the returns on bonds to go back to normal again?

So rigid was the developed world economy’s refusal to generate inflation, and so eager have been central bankers to drink bonds at the first whiff of anxiety, that it was hard to foresee any trigger that could cause a red-blooded credit sell-off.

No one imagined the needle that pricked the bubble would be a microscopic organism inside a bat.

Now, the bond market is once again a colourfully varied field, rich with opportunity for investors. Companies are crowding in. Almost all are welcomed, but on very different terms.

Investors are sorting industries ruthlessly according to how exposed they are to the coronavirus’s blight.

Sector is all — credit ratings count for nothing. Volkswagen Financial Services, rated A3/BBB+, paid 330bp over mid-swaps for five year debt last week. Healthcare company Fresenius, on the bottom step of investment grade, raised 7.5 year paper the same day at 190bp.

At long last, investors can flex their credit analysis muscles and really price risk.

But there’s a paradox. The market is bursting with record issuance and enormous books — except where it isn’t: in high yield.

Speculative grade rated issuers are no doubt partly to blame for the market’s paralysis. If they don’t issue, there is no way to test demand. But if investors were that eager for their paper, issuers would be tempted.

While investment grade fund managers may scoff at ratings and say they judge companies on their specific merits, they only dare venture so far.

The ratings cliff at the bottom of investment grade is a physical feature of the debt landscape that looms as starkly as ever.

By Jon Hay
08 Apr 2020