Bond Outlook by bridport & cie, January 30 2013
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Bond Outlook by bridport & cie, January 30 2013

Some specific issues related to the primary market may be additional signs of a credit bubble.

Without pretending to be exhaustive, we would like to draw your attention to three specific issues related to the primary market:


Firstly, some issuers are reducing the indicated yield targets during the subscription process,


Secondly, we have also observed an acceleration of early redemptions,


Lastly, investors in EMU government bonds are likely to become more familiar with the notion of CAC.


Let start with a quick review of 2012


Issuance was extremely robust last year. While smaller corporates shifted towards the bond market at the expense of traditional bank funding, established issuers reduced their dependence on loan funding in favour of bonds as new bank funding has frequently proven harder to obtain. In addition, many companies borrowed more than necessary relative to upcoming maturities and capital funding needs, in order to take advantage of ultra-low interest rates. The extra proceeds were likely used to pre-fund some of the expected 2013 issuance.


Despite the heavy volume of issuance, one of the defining features for 2012 for many investors was the struggle to get allocations in heavily oversubscribed primary markets. In fact, the minimal new issue premium to secondary curves seen towards the end of 2012 reflects the on-going high level of investor demand.


2013... better allocation, but another setback


As usual, January has been a relatively active period for new issues. While we have seen some improvement in the allocation rates, some recent issues where the books were hugely oversubscribed were issued a lot tighter than expected. Issuers have reduced their yield guidance through the subscription period. A good example was the recent USD Mafrig’s issue, with a first guidance around 10.50 – 10.75% and a final pricing at 9.875%.


We even saw the case of a primary issue which was more expensive than an equivalent secondary market bond (Gas Natural in CHF). As a consequence, we would recommend investors paying strict attention to the pricing of new issues.


Earlier redemption features may be activated


In the context of high demand and a low yield environment, issuers might also be inclined to exercise their right of earlier redemption. Earlier redemption features include tender or optional features like a call date or a make whole call option.


A tender consists of issuing new debt, and using the proceeds to tender for the existing bonds. Tenders become more attractive when the older bonds trade at high prices as issuers can lower interest costs going forward. In addition, improvements to earnings and an acceleration of tax benefits are other incentives. Iberdrola for example used this option last week.


Another particularly attractive strategy is using the make whole call option associated with some bonds. Spreads that are below the make-whole call level create the opportunity to take out bonds cheaper than in a tender. Typically, make-whole spreads are set very low, at about 25bps. However, in the environment of wider spreads in 2008 and 2009, make-whole levels were reset higher, close to 40bps, with some going up to as high as 75bps. Currently, a number of bonds trade tighter than these make-whole call spreads, particularly in the front-end.


CACs: a new feature on 2013 EMU Issuance


2013 also marks the first year that all new euro government securities with a maturity above one year will include a Collective Action Clause (CAC). We remind you that a collective action clause allows a supermajority of bondholders to agree on a debt restructuring that is legally binding on all holders of the bond, including those who vote against the restructuring.


This new feature may result in two different kinds of EMU government bonds: existing bonds and taps without any CAC feature, and new bonds issued from 1 January 2013 containing CACs. Will the two types of bond trade at different levels? Not necessarily. If the market does not anticipate any risk of restructuring for the country, the cost of the CAC feature will tend to be close to zero.


This new feature did not appear to influence demand for Spain’s Jan. 22 bond sale, which was unmatched in the country’s history.



Caroline Weber, CFA
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