Corporate bonds: QE and negative rates warp credit markets
Investors forced out along the curve; issuers play currency and duration game.
Quantitative easing in the eurozone, together with negative short-term deposit rates at the ECB and among several European countries, is forcing some peculiar distortions in the corporate bond markets.
Chris Bowie, at TwentyFour
Nominal yields on German, Swiss and Danish government bonds have turned negative as a result of these extraordinary monetary policy actions, in turn creating an extraordinary knock-on impact on corporate credit.
Corporate spreads have been in free-fall as investors have sought alternatives to government bonds, even to the point of pushing yields on the bonds of companies such as Nestlé into uncharted negative territory.
Yields on Nestlé’s Swiss franc bonds turned negative in January. At least one of its euro bonds – its €500 million 2016 – followed suit last month too.
It forms part of a compression trend that has seen corporate bond spreads fall by at least 10 basis points versus Libor since the beginning of the year and right across maturities of three to five years and 10 years and out.
That the ECB is not buying corporate bonds as part of its QE programme makes the spread compression in corporate credit all the more striking.
For investors, this has meant having to move down, and especially out, along the credit curve in their hunt for yield. Chris Bowie, partner and portfolio manager at TwentyFour Asset Management, says he is buying “new corporate bond issues at yields lower than he normally would” too.
He gives the example of buying into the dollar tranches of UBS’s recent additional tier-1 capital bond – the first to be sold from its new holding company – both of which were priced at issue to yield over 7%.
Without QE, those yields would undoubtedly have been higher.
“QE will have many first (direct asset purchases), second (portfolio) and third order (growth) effects – the immediate first and second round effects are why we are overweight credit risk,” says Bowie.
Jonathan Brown, head of European fixed income syndicate at Barclays, says corporate issuers are taking advantage of such demand. Coca-Cola’s recent €8.5 billion issue – the largest ever from a US firm in Europe – demonstrates this.
Several insurance companies we know of have had to
“What has been happening between the dollar and euro markets is very distinct. We haven’t seen this duration/currency dynamic for some time,” he says. “Global issuers that can borrow in either currency, can essentially raise more efficient funding out to five-years in dollars, and beyond five-years more efficient funding – and larger than they’ve done before – in euros.”
He gives the example of Norwegian oil and gas company Statoil, which last month raised €3.75 billion – its largest bond issue – through a 4.5-year floating rate note and three fixed-rate tranches in tenors of 8-, 12- and 20-years.
Statoil, which typically funds in dollars, has accessed the euro bond market before but never anywhere close to this size or tenor.
What was surprising about the transaction is that all three of its euro tranches were priced tens of basis points inside where the equivalent deals would have been priced in dollars – and even when taking into account the unfavourable euro-to-dollar cross-currency swap.
Lead managers Barclays, BNP Paribas, Deutsche Bank and Société Générale priced the FRN at 20 basis points over Euribor, and the three fixed-rate tranches as 33, 43 and 60bp over mid-swaps.
At the shorter end of the curve, UK oil firm BP raised over $2.75 billion across four tranches last month in a deal comprising two-year floating rating notes, and three and five-year fixed-rate bonds, arranged by Crédit Agricole, Goldman Sachs, Mizuho and Royal Bank of Scotland.
The leads priced $1.25 billion of five-year fixed rate bonds at 80bp over the equivalent Treasury, and $850 million of three-year fixed-rate bonds at 65bp over. The $400 million two-year and $250 million three-year FRNs, were priced at 35bp over Libor and 42.5bp over respectively.
Historically, the dollar market has been more competitive on price than euros for investment grade issuers going out to 10 years, but QE has effectively flattened the euro yield curve, making longer-term funding more competitive for issuers in euros from five years and out.
“We were joking the other day that a seven-and 12-year dual tranche euro from last year is, on pricing, an eight- and 20-year today,” says one syndicate banker. “That’s where we have moved to. There’s been no change in the investor base, it’s just moved out along the curve.”
He adds: “Several insurance companies we know of have had to drop yield targets they had had for a long time and have had to go longer to get anywhere near the returns that they need.”
And yet demand has moved into higher-risk areas of the curve too, and in some fashion.
Total’s debut sale last month of €5 billion of hybrid capital bonds – arranged by Barclays, Citi, HSBC and Société Générale – which attracted a staggering €20 billion of orders, underscores this.
“The size of recent hybrid deals we have seen would be materially smaller if it were not for the recent moves by the ECB,” claims Brown.
Bankers say pricing may not have differed that much at all had this deal come in more normal market conditions, but could Total’s perpetual non-call six and non-call 10 have been priced to yield a skinny 2.25% and 2.625% respectively if the ECB had not launched QE earlier this year?
Over mid-swaps, the non-call six tranche was priced at 186.1bp and the non-call 10 at 189.8bp, implying senior-subordinate differentials of 165bp and 155bp respectively.
Such yields may be skinny, but at least investors are being paid.
Investors now have to lock-in a loss for the privilege of lending Swiss francs over five-years to companies from Germany’s BMW to France’s LVMH and the UK’s BP, and now even short-dated euro bonds of Nestlé.
As Bowie says: “Negative yields from a risk-free government investment are one thing – paying a company to probably return your own capital to you in three years with no guarantee is quite different altogether.”