Fed Bond Rout No Europe Crisis as Sales Climb: Credit Markets
Even as corporate bonds face the worst losses since 2008, borrowers are still locking in cheaper financing than when Europe’s common currency was in jeopardy of breaking apart amid the region’s sovereign debt crisis.
Relative yields on company bonds from the U.S. to Europe and Asia widened as much as 42 basis points the past two months, less than a third of the 140 basis-point surge from August to October 2011, when European policy makers negotiated an accord with Greece’s creditors to avoid a default that threatened to unravel the euro zone, according to Bank of America Merrill Lynch index data. Dollar-denominated bond offerings surged last week to $24.1 billion, the fastest pace in almost two months, data compiled by Bloomberg show.
While the pace of debt sales will probably slow from the unprecedented volumes earlier this year, investors are returning to lend at interest rates that are 1.4 percentage points lower than the 10-year average. Strategists at lenders from Barclays Plc to Royal Bank of Scotland Group Plc foresee a pickup in offerings from the 18-month low in June.
“Concern about corporate creditworthiness isn’t uppermost in people’s minds right now,” Edward Marrinan, a macro credit strategist at RBS Securities in Stamford, Connecticut, said in a telephone interview. “The concern they have in their minds is interest-rate volatility.”
Treasury yields surged to the highest level in almost two years after Federal Reserve Chairman Ben S. Bernanke laid out a potential timeline on June 19 for policy makers to begin slowing monthly bond purchases this year. That spurred a 2.4 percent decline last month for corporate bonds, the biggest loss since October 2008, as average yields climbed to as high as 3.92 percent on June 25 from a record-low 3.09 percent on May 2, according to the Bank of America Merrill Lynch Global Corporate & High Yield Index.
The rout did little to shake investor confidence in company creditworthiness. The extra yield corporate-bond buyers demand to own the debt rather than similar-maturity Treasuries, which climbed to as high as 235 basis points last month and was 224 basis points yesterday, is 42 basis points less than the average of the past two years and down from a more than two-year high of 370 in October 2011, Bank of America Merrill Lynch index data show.
Corporate-bond yields at 3.71 percent yesterday remained 1.39 percentage points below the three-year high reached in October 2011 and compare with a 10-year average of 5.1 percent. The securities have generated 1.3 percent of excess return over government debt in 2013, even as they lose 0.8 percent of total return, Bank of America Merrill Lynch index data show.
“Positive sentiment has returned to the market with greater rate stability,” Barclays Plc strategists Jeffrey Meli and Bradley Rogoff wrote in a July 12 report. “We are as positive on credit risk as we have been all year.”
Elsewhere in credit markets, Royal Bank of Canada, the nation’s largest lender by assets, is planning a benchmark offering of three-year covered bonds in the U.S. Vivarte SAS, a French fashion retailer owned by Charterhouse Capital Partners LLP, breached the terms on about 2.8 billion euros ($3.7 billion) of loans, according to three people with knowledge of the situation.
The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark used to hedge against losses or to speculate on creditworthiness, rose from a more than six-week low, climbing 0.9 basis point to a mid-price of 77.9 basis points as of 11:36 a.m. in New York, according to prices compiled by Bloomberg.
The indexes typically rise as investor confidence deteriorates and fall as it improves. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
The U.S. two-year interest-rate swap spread, a measure of debt-market stress, decreased 1.4 basis points to 16.7 basis points. The gauge typically narrows when investors favor assets such as company debentures and widens when they seek the perceived safety of government securities.
Bonds of New York-based Morgan Stanley are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 4.8 percent of the volume of dealer trades of $1 million or more, according to data from Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
RBC may sell its covered bonds, expected to be rated Aaa by Moody’s Investors Service, as soon as today, according to a person with knowledge of the transaction. The notes, a form of secured financing pioneered in 18th-century Prussia, are backed by assets such as mortgages or loans and guaranteed by the issuer, letting banks fund more cheaply than with traditional debt and providing investors with top-rated securities.
Credit Suisse Group AG, Morgan Stanley, and Toronto-based RBC are managing the offering, said the person, who asked not to be identified because terms aren’t set. Benchmark sales are typically at least $500 million.
Vivarte’s ratio of earnings before interest, taxes, depreciation and amortization was 6.96 times at the end of May, exceeding the limit of 6.05, said the people, who asked not to be identified because the matter is private. The Paris-based company also breached its interest-cover ratio, a measure of how easily it can pay interest. That ratio was 2.17 times in May, below the minimum threshold of 2.25.
The owner of the Kookai clothing brand told its lenders about the breach yesterday, the people said. Charterhouse has five business days from the date of the infraction to address the matter, they said.
Marc Lelandais, chairman and chief executive officer of Vivarte, declined to comment on the breach. The company has 600 million euros of cash and no debt maturity issues in the next few years, he said in an e-mailed statement. Officials at Charterhouse in Paris declined to comment, citing company policy.
Borrowers are returning to the corporate-bond market after offerings in the U.S. fell to $55.5 billion in June, the least since December 2011, Bloomberg data show. Dollar-denominated deals increased last week to the most since $36.8 billion in the five days ended May 24, Bloomberg data show.
The issuance is helping to keep sales worldwide of $2.11 trillion this year on pace with 2012, a record year with $3.98 trillion in offerings.
While issuance for the rest of the year isn’t likely to match the $2 trillion sold during the first half of 2013, “risk aversion of recent months will fade and investors’ hunger for yield will reassert,” RBS strategists led by Marrinan said in a June 28 report.
Barclays strategists predict that borrowers will sell as much as $300 billion of speculative-grade bonds in the U.S. this year. That’s about $90 billion more than had been issued through yesterday, Bloomberg data show. They forecast $1 trillion of dollar-denominated investment-grade bonds, about $383 billion more than sales so far.
“Because so much of the issuance that we’ve seen over the last few years have been refinancing-based, companies can be smart about timing, about when they want to come to market,” said Rogoff, head of credit strategy at Barclays in New York.
During the selloff last month investors reduced their holdings of the debt, with concern mounting that interest rates would rise faster than they initially expected as the U.S. central bank began to wean the economy from its bond purchases.
The Fed has helped spur more than $5.8 trillion of U.S. company debt sales since the end of 2008 by suppressing borrowing costs through bond purchases and holding its benchmark interest rate at almost zero, Bloomberg data show. The securities have returned an annualized 11.4 percent during that period after losing 10.9 percent in 2008, according to the Bank of America Merrill Lynch U.S. Corporate & High Yield Index.
With such easy access to debt markets, corporate defaults for the riskiest borrowers have dropped. The trailing 12-month global speculative-grade default rate fell to 2.8 percent at the end of June from 3.1 percent during the same period last year, according to Moody’s.
“It just takes a little while for issuers to get more comfortable with the new rate environment,” Simon Mayes, head of the financial institutions group syndicate at BNP Paribas SA in New York, said in a telephone interview. Borrowers “are still suffering from a little bit of sticker shock in terms of yields on deals that they could have issued a couple of months ago versus today.”
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