Spreads in Europe’s high grade market have been grinding tighter thanks to the European Central Bank’s two corporate bond buying initiatives — the Corporate Sector Purchase Programme (CSPP) and the Pandemic Emergency Purchase Programme (Pepp).
This has escalated in the last week, after it emerged that the central bank bought record levels of bonds.
“With a volume of €44bn,” said Oliver Marx, a financial analyst at RBI, “more securities were bought than ever before in a single week.”
Of this, €34bn came from the Pepp.
Tightening spreads have led to companies returning to the market repeatedly to secure ever-cheaper funding. This week, German auto company Daimler and French energy firm E.On both printed well inside where they came at the end of March, and for much longer dated debt.
The size of the spread moves has caused some disquiet among investors. “We made some purchases at the wides,” said one portfolio manager, “but it looks like some companies have gone a bit too far and you’re getting a sense that there is going to be some resistance soon.”
Not every issuer has it so easy. Harley-Davidson caught the attention of the market this week when it opened books on a three year deal at an eye-watering margin of 450bp over mid-swaps. The €650m 3.875% May 2023 deal was eventually launched at 420bp over.
The company came to the euro market because “if you are [in trouble] in euros, you are doubly [in trouble] in dollars”, said a source close to Tuesday’s deal.
Harley-Davidson did not respond to a request for comment.
This was, by far, the widest spread the corporate market has seen since March 9, when global asset prices first plunged due to the pandemic. It is also despite Harley-Davidson being well rated at Baa2/BBB-/A- (all of the ratings have negative outlooks).
High price or not, the company proved it could still access the debt markets, and that should be taken as a win of sorts for other borrowers facing unprecedented tough times, according to some.
“It shows that there is a price,” said a bond analyst at an asset manager. “These companies can come, but they need to accept the new reality. I’m not sure how many more would really be willing to do that. It really shows how much you need the money if you are.”
The investor added that airlines would still be unable to issue in euros.
Harley-Davidson needed the money. The company announced swingeing spending cuts at the end of April to save $250m this year, as worldwide sales for the first quarter fell by 17.7%.
Shy on spreads
Issuance at the widest levels is unlikely to be a frequent occurrence. “We’re not going to have people beating down the door to issue at that level,” said the London-based syndicate banker.
But now might be the best time for besieged companies to try and sell bonds. The spread between companies that have been worst affected by the crisis and those less impacted is expected to widen further.
“We’ve yet to see the worst of it,” said a bond strategist. “Companies could be kept on as zombies, but I expect to see some become insolvent.”
The portfolio manager said: “I don’t think the rating agencies are done downgrading by any means. As we see people continue to issue, companies are leveraging out to try and support themselves through however long this crisis will last. If [the companies] continue to lever, [the agencies] will have to factor that into their ratings.”
Increased debt burdens come at the same time as sharply reduced revenues for many companies, which will turbo charge leverage.
After downgrading Harley-Davidson a notch at the start of April, at the end of the month Moody’s said the company had a strong brand, healthy balance sheet and adequate liquidity position but it faced big challenges.
“Harley-Davidson is vulnerable to shifts in market sentiment in these unprecedented operating conditions and remains at risk of the outbreak continuing to spread,” said the agency. “Moreover, the outbreak is occurring as the company is in the middle of implementing a long term plan to stem the secular decline in its core US market, and to expand internationally.”
Not a-loan
This might mean that more borrowers that operate in sectors badly affected by the pandemic need to turn to other sources of funding, with the loan market being a potential source. However, even the loan market might be tough for the trickiest borrowers.
“It’s not a question of pricing anymore,” said one loans official at a European lender. “Now the results are out you can really get a sense for how bad it is. If you don’t already have the strong relationship then you are going to have a difficult time getting a new client through a credit committee.”
There are ways around this. Sovereigns have shown that they are willing to back some sectors and that is enough to get banks on board. Spanish airlines Iberia and Vueling, both part of the International Airlines Group, have signed syndicated loans totalling €1.01bn on the condition that the state owned Instituto de Crédito Oficial guarantees the financing. Nordic airlines have made similar deals.
“You have to come with some sort of credit enhancement,” said the loans banker. “If you have a very deep relationship and you provide other business for the bank, like cash management, then you will probably be OK.”