Company Bonds `Ripe' for Rally in Europe as Cash-Rich Investors Seek Risk
Company bonds will rally throughout 2010 as cash-rich European investors seek out riskier assets on optimism a sovereign default has been avoided and that banks are now able to fund themselves, according to Barclays Capital.
The extra yield buyers demand to hold corporate notes compared with government debt will shrink until the end of the year, Barclays strategists said. Limited issuance this year has left investors with cash on hand and company bond funds will likely benefit as returns on sovereign debt remain low.
“With the immediate tail risks of a European sovereign default and a bank funding crisis diminished, investors are now looking at credit through the prism of economic growth,” strategists led by Aziz Sunderji in London wrote in a note. “We continue to believe conditions are ripe for spread tightening until the end of the year.”
The premium investors demand to hold European investment- grade bonds rather than government debt held at 177 basis points, according to Bank of America Merrill Lynch index data. The spread tumbled from May’s peak of 204 basis points after company earnings beat analysts’ estimates and positive results from bank stress tests on July 23 buoyed sentiment.
Sales of new company bonds in Europe plummeted 73 percent to 9.4 billion euros ($12 billion) so far this month, compared with the first three weeks of July. Issuance this year totals 404 billion euros, half the amount raised in the same period in 2009, according to data compiled by Bloomberg.
“Europe remains in the grip of the summer lull in terms of primary activity for now, but we expect the European market could reopen strongly in early September,” said Vivek Tawadey, head of credit strategy at BNP Paribas SA in London.
With European investors on the summer sidelines, companies are issuing dollar-denominated debt at a record pace with $125 billion raised so far, compared with $120 billion in the same period in 2009, according to Bloomberg data.
Royal Bank of Scotland Group Plc, the U.K.’s biggest government-owned bank, and Dutch lender ING Groep NV helped drive sales to $7.3 billion this week, the most in over a month, Bloomberg data show. Banks are taking advantage of demand from U.S. investors and the gains that can be made from swapping dollar payments into euros.
The extra yield investors demand to hold company bonds in the U.S. currency fell to 188 basis points, close to the lowest since May 19. The cost of converting dollar payments into euros, as measured by the five-year euro basis swap, is 28.5 basis points below the euro interbank offered rate, or Euribor, prices on Bloomberg show.
“There remains a funding need among banks and with the cost of borrowing looking relatively attractive for European issuers given the basis swap, lenders are seizing the window of opportunity to get deals done in the U.S. while Europe remains closed for the summer,” said Jeroen Van den Broek, a credit strategist at ING in Amsterdam.
RBS sold $3.6 billion of dollar-denominated senior unsecured debt on Aug. 17 in its first benchmark issue in the currency since March 9. The bank issued $600 million of three- year floating-rate notes and $1.5 billion each of three- and 10- year fixed-rate debt, according to data compiled by Bloomberg.
The floating notes paid 242 basis points more than the three-month London interbank offered rate, while the other three-year debt paid 265 basis points more than Treasuries, and the 10-year notes a 300 basis-point spread, Bloomberg data show.
“Spreads have come down for banks after the stress test results were well received by the market and pent up demand for new notes remains among investors,” according to ING’s Van Den Broek.
ING raised $750 million of five-year notes on Aug. 17 at a spread 162.5 basis points more than similar-maturity Treasuries.
HSBC Holdings Plc, Europe’s biggest bank, also sold dollar- denominated debt the same day, issuing $1.25 billion of 10-year subordinated notes. The debt was priced at a spread of 225 basis points and now trades 35 basis points tighter at 192 basis points over Treasuries, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.