January 4, 2012 4:37 pm
Euro crisis boosts appeal of ‘safe’ companies
Even Europe’s largest and most solid companies started feeling the heat of the eurozone crisis late last year, sending yields on corporate bonds higher and denting their reputation as a haven.
Yet investment grade company bonds are now reasserting their secure credentials. Indeed, some highly rated European corporate bonds are trading at lower yields, which move inversely to bond prices, than those on government debt issued by the countries where they are based – particularly in Europe’s embattled “periphery”.
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This is a striking divergence from financial custom. Company debt has historically been priced and traded at a certain premium above government debt, the so-called “risk-free rate” for which interest rate changes was the main danger, not defaults.
“That corporate debt is perceived as safer than government debt in many cases is a huge paradigm shift,” says Philippe Berthelot, head of credit at Natixis Asset Management. “A lot of asset classes have lost their reference point now.”
Energias de Portugal, the utility, early last year sold a bond that was priced to yield less than the country’s bonds at the time. The difference, or spread, to comparable Portuguese bonds has now widened to more than 7 percentage points in EDP’s favour.
An €850m bond recently sold by Repsol, the Spanish oil and gas producer, now trades at a yield just below Spain’s comparable bond yield. In Italy, Enel’s 2022 bond currently yields about 6.18 per cent, compared with Italy’s 6.92 per cent 10-year borrowing costs.
It is not just in the eurozone’s periphery where anomalies like this are becoming common. Bonds sold by Sanofi, the large French pharmaceuticals group, that mature in 2016 yield 1.9 per cent, against a yield on comparable French government debt of 2.1 per cent.
The US was stripped of Standard & Poor’s top rating this summer, while a smattering of US companies have kept the rating agency’s triple A grade. Yet even they still trade at a premium to Treasuries. Jason Brady, a portfolio manager at Thornburg Investment Management, says negative spreads in the US could “easily happen, but I highly doubt they will”.
Ratings aside, no corporate bond can compete with the liquidity of US Treasuries. In extremis, the US controls its own monetary policy and can print money to repay debts in its own currency, an option not available to peripheral eurozone countries.
The spectre of default hung over US Treasuries in August when lawmakers were gridlocked over raising the US debt ceiling. “But this was more about the willingness to pay rather than the ability to pay,” says James Keenan, a managing director at BlackRock.
In contrast, bankers and analysts predict that the safest, most highly rated European companies will this year trade more often at yields below those of comparable government bonds, as investors hunt for safer assets to park their capital.
“Given the macro themes that are affecting Europe, it’s possible that in 2012 we’ll see more solid European corporate bonds trade tighter than the bonds issued by their respective sovereigns,” says Huw Richards, managing director of debt capital markets at JPMorgan in London.
The price of credit default swaps, products that insure against defaults and are widely used to hedge risks, on western sovereign debt has climbed to 369 basis points, from 212bp at the start of last year, according to Markit. This means it costs €369,000 annually to insure €10m of debt against default for five years.
Markit’s index of European investment grade corporate debt CDS has also climbed, though more modestly, to 173bp, from 108bp at the start of 2011.
“The differential between the ‘risk-free rate’ and investment grade corporate debt is likely to narrow this year,” argues Jonathan Pitkanen, head of investment grade research at Threadneedle.
“Insurers and other big investors are starting to regard them as the new safe haven.”
Should the eurozone crisis worsen, however, even the safest corporate bonds are likely to be dragged into the maelstrom.
Mr Berthelot argues that high-grade company debt trading at lower yields than the sovereign is not sustainable in the longer run, and that something will have to give eventually.
“We have to adapt to this new paradigm, but it is not a friendly environment for fund managers,” he says. “We will have to get used to spectacular volatility.”
Many bankers argue that safety is relative, pointing out that all asset classes would be hammered in a financial cataclysm. While turmoil in the sovereign debt markets reverberates rapidly in corporate debt, calm returns swiftly as well.
Citigroup’s credit analysts expect European investment grade bonds to tighten up to 25 per cent from current levels, implying returns of 3-6 per cent this year – assuming policymakers are able to contain the sovereign debt crisis.
Giles Hutson, head of European debt capital markets at Bank of America Merrill Lynch, says: “Corporates cannot decouple completely from their sovereign, but people tend to throw the baby out with the bathwater initially, and once they take a step back they take a more nuanced view.”
Copyright The Financial Times Limited 2012.
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