The near shutdown of the investment-grade corporate bond market during the past few weeks has led to much discussion of whether the market is witnessing a credit crunch. The reality appears to be something more benign. Although there is less liquidity, amid difficult primary market conditions new issues can still be sold – at the right price.
"The main story in the primary market is one of a very fast deterioration of liquidity," says Geert Vinken, global head of syndicate at Barclays Capital. "The days of order books that are five, eight or 10 times oversubscribed are over, it seems. Although some liquidity has been withdrawn, there has not been a complete collapse in investor confidence, simply a repricing of risk."
Toby Nangle, head of global aggregate business, fixed-income and currency team at Baring Asset Management, says: "Credit crunch is something I think that is quite specific – you don’t get BBB rated bonds pricing during a credit crunch. It looks like the market is beginning to discriminate at last."
He continues: "We are starting to see some signs of credit rationing for the riskier deals, and have counted 28 corporate bond or loan deals representing around $17 billion that have been pulled since June 22. We didn’t count a single pulled deal in the previous year."
There is little doubt that investors are increasingly concerned about leveraged finance deals, understandably, as they constitute the riskier end of the credit spectrum (see Crunch time for LBOs). But of those that have withdrawn from the market, at least 12 were investment-grade credits. These include Caixa Galicia, Banc Agrileasing, NIBC Bank, Aozora Bank, Bank of Moscow, First Gulf Bank and, in the pure corporate world, such names as Arcelor, MISC, Rosneft, Prologic, KIA Motors, and PKN Orlen. All of these simply did not like the implications that market volatility during June and July – widely gauged from the Crossover index’s performance – had for new-issue premiums.
Polish oil company PKN Orlen announced a seven-year euro deal via ABN Amro, BNP Paribas, Citi and Société Générale one morning in July and withdrew from the market just three hours later. It is on the cusp of investment grade, rated Baa3/BBB–/BBB–, but there is no question that a deal could have got done. It appears that the borrower did not like the fact that it would have to pay 10 basis points or so more than it expected when the deal’s process started, although 100 basis points over swaps would not seem that substantial a premium. It was a similar story with Rosneft, which went on the road in mid-July in preparation for a $2 billion to $3 billion dual-tranche (five and 10 year) transaction via ABN Amro, Barclays Capital, Citi and Morgan Stanley. Rosneft was refinancing some of the $24.5 billion loan it took out to buy Yukos. It has investment-grade ratings with Moody’s and Fitch (Baa2/BBB–) but is non-investment grade according to S&P (BB–). It was a surprise that the borrower was not happy to pay a few extra basis points in order to get the deal away.
"The move in investment grade has been relatively minor," says Nangle. He argues that the widening of credit – for instance the option-adjusted spread on US single As has gone from 80 to 100 basis points – is not a big move, especially by historical standards.
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"I don’t feel well paid for taking investment-grade exposure," Nangle says. "Spreads are drifting wider; it feels like we could be replicating the period of 1997/2000 when equity markets were booming and enhanced shareholder returns were financed by debt. It feels like a generally bondholder-unfriendly environment."
Investors such as Nangle are not calling for wider spreads as such, more for a change in the corporate finance environment. He is wary of a constant supply of loans and bonds from companies seeking to give cash to shareholders, although every one has their price. "If single As were at 140-160 basis points over, well I suppose that is great value!" he says.
Despite the negative headlines in sub-prime and leveraged finance, all market participants – on the sell and buy sides – point to strong economic fundamentals and continued good corporate earnings.
"There isn’t a lot of good news but technicals are OK, generally," says Charlie Berman, co-head of fixed income capital markets at Citi.
"Rates have risen – after a long period with no movement, 10-year UST yields went from 4.65% to 5.35% but are now hovering around 5% – but equities remain robust. Credit spreads are off their tights but still aren’t wide by historical standards. The concerns involve things that many people don’t really understand or which are difficult to quantify such as exposure to US sub-prime mortgage loans. Investors and traders are also defensive about the leveraged finance market given the recent focus on covenants, weakness in spreads and the substantial forward calendar. However, real money liquidity remains high and there are certainly buyers for the right deals."
Every time a deal is pulled from the market several other corporates conclude that it would be better to wait until the traditional reopening of the European bond market in September. Supply considerations will now be the driver of primary market pricing in the coming months.
"So now we are looking at a large pipeline in investment grade after the summer. What does this mean for the market?" ponders Barcap’s Vinken. "Well, we might see some borrowers move to US dollars because they like the short execution window. But a lot cannot take that option so I think in September we will see huge supply on the days the market is open."
According to DCM bankers, the known euro investment-grade corporate pipeline is in the region of €40 billion. Of that pipeline, somewhere between 25% and 30% should have printed before the summer slowdown.