By Dwight Cass
Bond issuance and trading volumes in the US and Europe are at multi-year highs as investor confidence grows.
The US and European bond and loan markets showed no signs of cooling down in March, as good news continued to spur increases in investor risk appetite after a frenetic February. Investment-grade corporate new issues have enjoyed some of the lowest yields in 40 years, as US issuance alone hit a record $98.1 billion for February.
The apparent success of the ISDA/Markit auction held to ascertain the payout on Greek CDS on March 19, and strong investor reception for a debut 20-year EUR1.5bn European Financial Stability Facility bond the same day—even after absorbing a EUR7bn-plus glut of bonds the week before—were the latest of a series of positive developments that have set investor pulses racing.
The loan and high-yield markets likewise were busy. Borrowers looking to fund dividends or stock repurchases raised $20.7 billion in the first ten weeks of the year, up from $2.3 billion in the fourth quarter, according to S&P Loan Pricing and Commentary. The majority of this debt (51 percent) was raised by private equity-backed companies looking to fund dividends and other payouts to themselves.
Bankers argue that all this new issuance won’t slake investor appetite any time soon, since, for example, over 60 percent of the proceeds raised in the US bond market is slated for debt refinancing, meaning the net amount of outstanding debt will grow less than the eye-popping gross issuance makes it appear.
NARROWER SPREADS OFFSET
The market is this active despite a sharp uptick in benchmark rates. Narrower spreads on risk assets offset these higher yields in investors’ eyes. Treasury prices, in particular, have been hard hit in re- cent months, as improvement in US economic indicators, a reversal of the Greek default-inspired flight-to-safety, and strong gains in equity markets prompted investors to leave the sidelines.
After a long stretch of range-bound trading, the sharp decline in Treasuries had many investors wondering if the “bubble” in that market had finally popped – a question raised with some regularity for the past four years. It turned out to be false in 2011, when long-term Treasuries and munis wound up being the best performing assets,
to the chagrin of bond shamans like Bill Gross. But even if the air does leak out of Treasuries for the long-term, it should have little effect on the attractiveness of spread products.
A EUROPE DIVIDED
Eurozone corporates have been the biggest beneficiaries of investors’ renewed interest in corporate bonds. Those with 2012 refinancing programs are expected to “face fewer challenges” in completing them, according to Fitch. That’s because industrial corporates are less affected by the Eurozone sovereign debt crisis than banks, whose sovereign exposures are still a source of concern.
But banks, especially those on the periphery, may continue to struggle to meet refinancing targets. In its recent quarterly market overview, the rating firm said that financials have EUR431 billion in bonds maturing this year, or 107 percent of their entire 2011 new issuance. By contrast, Fitch noted that industrials have only EUR126 billion, or 66 percent of their 2011 issuance, coming due this year.
Even so, market perception is that financial institutions’ credit risk has nonetheless declined, if only a bit. On the day of the Greek CDS auction, the iTraxx Financial Index linked to senior debt fell three basis points to 188 and the subordinated index dropped five to 324, according to Bloomberg. Compare that with the iTraxx Crossover Index of high-yield companies, which dropped 12 basis points to its lowest level since August 4. (CDS spreads on Western European sovereigns widened slightly.)
“Most of the US issuance at the beginning of the year was more or less forced,” says one DCM banker in New York. “Until the Greek situation got some clarity, there was a wait-and-see consensus.” But the floodgates opened in February, as the new European bailout fund became a re- ality. And many corporates had teed up deals to spring on the market at the first opportunity.
The market’s momentum since then has made it easy for corporates to borrow, though perhaps harder for investors to hit their yield bogeys. Nonetheless, those investors who are feeling left out by equities’ big rise are happily moving down the fixed income credit scale in search of yield, setting aside thoughts of how fragile the current markets may be.
One fly straying worryingly close to the ointment is the behavior of the VIX S&P 500 volatility index. The VIX has more than halved since last August and is now below its long-term mean and 200-day moving average. Tech analysts say this means it’s primed to rise. The futures apparently agree: they’ve priced in an increase in equity volatility for later this year. If that happens, it will reflect an increase in investor risk aversion and deter new corporate issues as well.
And the assumed bulwarks against a market retrenchment are not as solid as some assume. For example, there is widespread belief among investors, pundits and DCM bankers that the Federal Reserve has a QE3 waiting in the wings, ready to spring upon the markets if they falter. But as the Financial Times columnist Robin Harding recently noted, the Fed’s latest upgrade of its growth forecast indicates that it does not see the need for more easing, and may be turning its attention to inflation.
That’s not to say the corporate issuance window in the US or Europe will necessarily slam shut any time soon. But the torrid pace of issuance in both arenas shows recognition among corporates of the reality that the good times just might not last forever.