Crisis Erased in Europe Junk Bond Yield Premiums: Credit Markets
Rising confidence in the outlook for Europe has emerged in the region’s junk bonds, where investors have pushed yields to the lowest relative to investment-grade debt since the early days of the global financial crisis.
Speculative grade borrowers from carmaker Renault SA (RNO) to French phone equipment manufacturer Alcatel-Lucent and Portugal’s Telecom SGPS SA are paying an average 3.25 percentage points more to borrow than the safest debt issuers, Bank of America Merrill Lynch data show. The premium has shrunk from a peak of 20.7 percentage points in March 2009.
The riskiest corporate bonds are rallying along with government debt and the euro as the region’s fiscal crisis and threat of a currency break-up recedes. European Central Bank President Mario Draghi has expressed a greater willingness than his predecessor, Jean-Claude Trichet, to use the ECB’s resources to bolster the financial system.
“Given the relatively low defaults we’re experiencing, investors will continue to be enticed in to riskier names,” said Thomas Rahman, a credit strategist at Ria Capital, an Edinburgh-based fixed-income broker. “They’re looking at it on a relative basis and I expect there’s room for further tightening” in yield premiums, he said.
As central banks flood the global financial system with cheap cash, the corporate default rate is close to an all-time low, bolstering investors’ confidence to speculate on riskier assets.
The failure rate fell to 1.8 percent in Europe during the fourth quarter of 2012, compared with a global rate of 2.6 percent, Moody’s Investors Service said in a Jan. 9 report. The worldwide rate may rise to 3 percent this year, Moody’s said, still lower than the 4.8 percent average since 1983.
That’s helped cut the yield on junk debt to 5.3 percent from 12 percent at the start of 2012 and trigger a rush of issuance, with companies selling 3.5 billion euros ($4.7 billion) of securities this year, more than 10 times the same period in 2012, according to data compiled by Bloomberg.
Elsewhere in credit markets, the cost to insure U.S. company bonds from default rose for a second week, while global issuance of corporate debt tumbled 13 percent from the previous five-day period. Banks dominated sales in Europe.
The Markit CDX North American Investment Grade Index of credit-default swaps, which investors use to hedge against losses or to speculate on creditworthiness, was little changed last week at a mid-price of 87.1, according to prices compiled by Bloomberg. The measure reached 89.7 on Jan. 15, the highest this year.
The Markit iTraxx Europe Index of 125 companies with investment-grade ratings fell 1.25 basis points to 102.5 at 3 p.m. in London. The Markit iTraxx Asia index of 40 investment- grade borrowers outside Japan was little changed at 106.5.
The indexes typically fall as investor confidence improves and rise as it deteriorates. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a swap protecting $10 million of debt.
Bonds of Goldman Sachs Group Inc. (GS) were the most active dollar-denominated corporate securities last week, accounting for 4 percent of the volume of dealer trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
JPMorgan Chase & Co. (JPM) was the top underwriter in the $112.1 billion of global corporate bond sales last week, down from the $128.4 billion issued in the previous week, Bloomberg data show.
In Europe, lenders led by Spain’s Banco Santander SA (SAN) and Paris-based Societe Generale SA (GLE) dominated sales. Corporate issuance totaled 14.9 billion euros last week, 20 percent more than the average for the past year, according to data compiled by Bloomberg. Banks accounted for 8.2 billion euros of that, with Banco Santander and SocGen each issuing 1 billion euros.
High-yield bonds were the best-performing corporate securities worldwide last year, gaining 18.8 percent, compared with 10.6 percent for investment-grade, Bank of America Merrill Lynch index data show. The asset class also outperformed a 4.5 percent gain on global government bonds and has returned 0.1 percent this year, the data show.
Speculative-grade companies are rated below Baa3 by Moody’s Investors Service and BBB- by Standard & Poor’s and Fitch Ratings.
‘Whatever it Takes’
Confidence in Europe has improved since Draghi declared in July that “within our mandate, the ECB is ready to do whatever it takes to preserve the euro.” Europe’s common currency has climbed against all 31 of its world’s most-traded peers since then.
The Bloomberg European Financial Conditions Index rose to the highest since July 2007, while the benchmark Stoxx Europe 600 (SXXP) is approaching a two-year high and Spain’s 10-year government bond yields fell this month to the lowest since March.
Markets are rallying even as the euro-area economy won’t return to growth until the next quarter as a recovery in Italy is delayed and France continues to shrink, according to the median estimate of economists surveyed by Bloomberg.
Gross domestic product in the 17-nation currency region probably fell 0.4 percent last year and will decline 0.1 percent in 2013, according to the Jan. 17 forecast.
The first high-yield company to issue bonds in Europe this year was Fresenius SE & Co., the German private hospitals operator. The Bad Homburg-based company, ranked BB+ by S&P and Fitch, priced 500 million euros of bonds due July 2020 with a coupon of 2.875 percent on Jan. 10, according to data compiled by Bloomberg.
Austria’s Novomatic AG, the world’s second-largest maker of slot machines, priced 250 million euros of six-year bonds on Jan. 16 with a 4 percent coupon, data compiled by Bloomberg show. It was the unrated company’s cheapest financing in more than seven years and the relative yield on the notes tightened 11 basis points to 278 basis points more than the swaps rate since the sale, Bloomberg prices show.
Renault’s 600 million euros of 4.625 percent bonds due 2017 yield 289 more than the benchmark swap rate, narrowing from a high of 388 Oct. 1, data compiled by Bloomberg show.
The spread on Portugal Telecom’s 750 million euros of 5.875 percent bonds due 2018, sold in October, tightened by 152 since issue to 346. Alcatel-Lucent’s 500 million euros of 8.5 percent 2016 bonds yield 633 over swaps, from 870 last month.
In the U.S., the gap in yields between junk and investment- grade bonds narrowed to 3.7 percentage points as of Jan. 17, the least since July 2011, according to Bank of America Merrill Lynch index data. The difference declined from a 2012 peak of 4.88 percentage points on June 5.
Investment grade companies yield an average 2 percent, according to Bank of America Merrill Lynch’s Euro Corporate index, and some of the strongest borrowers pay even less. Bayerische Motoren Werke AG, the world’s biggest maker of luxury cars, priced three-year bonds with a 1 percent coupon on Jan. 15, its lowest-ever funding cost, Bloomberg data show.
Among investment-grade companies selling a total 35 billion euros of bonds this year, Madrid-based Telefonica SA, the BBB ranked telephone company, paid investors a coupon of 3.987 percent to buy 1.5 billion euros of 10-year bonds Jan. 8.
“Everyone’s taking on more risk and while it’s been that way for a while, the dynamic is accelerating,” said Norval Loftus, chief investment officer at broker Allegra Asset Management Ltd. in London. “People really need to adjust their definition of what high-yield means as we’re definitely in a bubble and, like all bubbles, eventually it’s going to burst.”
The cost of insuring against default on high-yield European companies is approaching the lowest in 18 months, with the Markit iTraxx Crossover Index of credit-default swaps on 50 mostly junk-rated borrowers declining 59 basis points since the end of 2012 to 423 basis points.
High-yield bond funds attracted more than $1.6 billion of cash in the first full week of January, according to data from EPFR Global, a subsidiary of Informa Plc, extending an inflow streak stretching back to late July.
“Flows into high-yield have just been non-stop,” said Matt Eagan, a Boston-based money manager at Loomis Sayles & Co., which manages $12 billion of high-yield bonds including $1.5 billion in European corporate junk debt. “It’s a natural part of the credit cycle that investment-grade yields get scrunched down so much that you have a core of buyers that will get in the crossover space to get a pick-up in yield.”
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