Credit Market Summary 17 October

Credit
Market
Summary
17 October
2014
Portfolio
Commentary
Punch
drunk
Henrietta Pacquement
Lead Portfolio Manager &
Head of Quantitative Analytics
It’s not easy weaning oneself off liquidity after years of
central bank largess. This week saw global equity markets
cave on the back of poor inflation numbers across the
globe and reduced global growth expectations. Add to
that concerns about Greece, Russia, the Middle East, oil,
Ebola and equities were faced with a powerful cocktail that
pushed a number of markets into correction territory if not
bear market territory in the case of Greece in the space of
a few days. This generated a bid for fixed income with quite
an extraordinary day on Wednesday where 10 year US
rates had a ‘flash rally’ and traded within a 35bps range in
the space of a few hours.
US 10 year government index on 15 October 2014
2.30
2.25
Top line growth has come under pressure over the last few
years in the US and in Europe with European revenues
dipping negative and US revenues showing only slight
progression recently. Companies are still reluctant, be
it in the US or in Europe, to put capital back to work in
the form of capex. The re-leveraging that is occurring in
the US is predominantly driven by shareholder friendly
activity in the form of M&A, dividends or share buybacks.
Europe is still working on balance sheet deleveraging and
is very conservative in terms of use of capital. European
companies are being hampered by poor revenue trends
in their efforts. In both the US and Europe this situation
doesn’t indicate strong growth prospects. It is also not
conducive to high levels of inflation as revenues are not
being used to hike salaries to maintain competitiveness.
This has been one of the issues highlighted by the Fed or
the BoE and one of the reasons central banks have been
reluctant to bring forward rate hikes.
2.20
2.15
HY revenue profile
Yield
2.10
2.05
2.00
1.95
USGG 10 year index
1.90
8 PM
7 PM
7 PM
6 PM
5 PM
5 PM
4 PM
3 PM
2 PM
1 PM
1 PM
12 PM
9 AM
10 AM
8 AM
6 AM
1.80
4 AM
1.85
15 October 2014
Source: Bloomberg
In light of these moves and disappointments about
earnings potential, it is worth reviewing corporate trends in
recent years to see if these moves are justified in equities
and what kind of blowback they may have into credit.
ECM Credit Market Summary
Source: J.P. Morgan
2
Investment Grade revenue profile
turn was also supported by more dovish comments from
Fed members given recent inflation trends. On Friday, the
European markets were given a boost by ECB comments
suggesting asset purchases would start within days.
It is worth noting that financial fragmentation remains
between Eurozone countries. Aggregate lending rates
to non-financial companies are still markedly higher in
countries like Italy and Spain compared to Germany or
even France. While progress is being made, the ECB is
keen to continue to close the gap. Inflation levels are also
too low in Europe. The ECB has a clear mandate to keep
inflation levels within target. As a result, the markets may
be underestimating the ECB’s willingness and ability to act.
Source: J.P. Morgan
Earnings prospects go some way to explain equity market
jitters. So where are we in the credit cycle in Europe?
Still in repair mode, with high yield potentially further
down the credit cycle than investment grade as growth
prospects remain subdued. For high yield, low growth
has more potential to put pressure on top lines and make
the deleveraging exercise more difficult. As a result, the
environment is arguably more supportive for credit spreads
in Europe than for equities and suggests credit spreads are
likely to remain range bound for now.
“…the ECB is still firmly
in easing mode and will
be taking up the torch of
quantitative easing.”
While the Fed is further ahead in its cycle and looking
to the next step of rate hikes, the ECB is in a different
situation. The ECB is still firmly in easing mode and will be
taking up the torch of quantitative easing. So the markets
are still likely to get their fix in months to come.
However, despite fundamentals, we are still clearly
in the hands of the central bankers. The markets are
hypersensitive to their next decisions. This week’s moves
highlight again how dependant markets are on their words
and actions. On Thursday, strong US data helped turn
sentiment turning the trend on US equities. However, the
ECM Credit Market Summary
3
Investment Grade
Corporates
Duncan Warwick-Champion
Co-Head of Global Credit Research
It’s been a tough week across many asset classes and
for once corporate credit was not immune during the selloff. Our traders reported a notable reduction in corporate
liquidity, even for some of the strongest credits across
various sectors, as investors stepped back from the market
in the face of escalating nervousness and the street
refused to step into the breach. Trading, and with it any
meaningful price indicators, virtually evaporated. Peripheral
credits were particularly impacted by uncertainty, as were
higher-beta names and hybrid securities. Overall the EN40
Corporate BBB index was 4bps wider on the week, which
felt painful as screen prices gyrated around us, but in
reality continues to offer relative stability when compared to
other risk assets. Given market anxiety and closed periods
ahead of Q3 results, the primary market was virtually
closed with SNAM, the Italian utility, being the only issuer
this week (€500m 9yr). We are aware that both Areva and
Arkema are sitting in the wings with potential issues for
next week.
Although only early days in the European Q3 reporting
season, the vast majority of results have so far been in-line
with, if not slightly ahead of, expectations; coupled with
affirmations of full year guidance. Interestingly, we have
already seen a number of companies pointing towards
a softening of operating conditions in Asia, particularly
China, offset by stronger operational performance from
Latin America. Weakness in European operating conditions
is simply a given. Another theme to emerge from early
reporting is the pace at which input price deflation, driven
by falling oil and food stock prices, is feeding through some
business models. We, like many other investors have
significantly lowered our oil exposures over recent weeks,
but correctly timing the entry point into beneficiary sectors
is a far more complicated dynamic to analyse.
Interest Rates
Alastair Thomas
Head of Rates & Treasury Management
This week 10 year treasury, bund and gilt yields fell further
(currently -10bps, -3bps, -4bps respectively). These
relatively small declines mask one of the most volatile
weeks in many years. This week’s range in the US 10 year
treasury yield was 41.6bps with 36.6bps on Wednesday
alone. The markets continued to be concerned about global
growth and low inflation, especially with the weak US retail
sales and Ebola incidents.
Last week I said one should buy treasuries on a break
of 2.30% and indeed once that level was breached and
the subsequent support of 2.20% the market went into
freefall for a couple of hours before starting the recovery.
Treasuries continued to outperform bunds and gilts on the
back of the weak US data despite Tuesday’s lower than
expected UK inflation and weak German and Eurozone
ZEW expectations indices. Weak commodity prices
fuelled dis-inflation/deflation concerns and Saudi Arabia
seems comfortable with oil nearer $80 a barrel compared
to their previous $100 level. This will impact economies
more dependent on oil revenues such as Russia, Iran and
Venezuela and keep global inflation low.
Other economic data was not so gloomy: UK
ECM Credit Market Summary
unemployment fell more than expected to 6.0%, the Fed’s
Beige Book reported moderate to modest growth, US
initial claims reached a 14 year low (and lowest ever as
proportion of the population) and US industrial production
rose 1.0% (expected 0.4%) with capacity utilisation back to
the highest since June 2008.
Central bankers seem to be changing views as rapidly as
the markets with the Fed’s Bullard advocating delaying
further QE tapering having just 8 days ago recommended
removing accommodation and not holding off on rate hikes
until the middle of next year. Likewise the BoE’s chief
economist Haldane is gloomier about the UK economy
having been in favour of sooner rather than later rate hikes
in the summer. However, he thinks the UK’s economy
remains strong and well-balanced.
I expect liquidity, which was already poor, will not
recover soon so markets will remain whippy. With CFTC
speculative positioning being the longest since 2012, new
trapped longs (very high volumes traded at the high prices
with open interest collapsing) and a base being put in in
stocks I would expect yields to increase at least in the short
term.
4
Loans
Sam McGairl
Lead Portfolio Manager
With increasingly wild gyrations in equities, treasuries and
high yield, this week has seen some softness creep into
the loan market in the previously resilient CLO segment
which makes up approximately 25% of the market. The
issue is not that CLOs have stopped buying, rather that
non CLO investors who hold these names have been
more inclined to sell them to re-invest in either USD
loans or other parts of the sub-investment grade credit
spectrum. There have been two BWICs this week which
have traded almost in their entirety. Where bids were not
so forthcoming it tended to be at the subordinated level.
Well rated Euro denominated names are now trading in a
99.5 to 100.5 range rather than a 100 to 101 range a week
ago. Relative volatility is still extremely low compared to
other asset classes or the US loan market, where the retail
flows (nearly $1bn redeemed this week) continue to drive
a repricing of the market. This retail volatility is absent from
European loans.
The new issue market continues to launch new
transactions to European investors. This week saw
meetings for refinancings of drug company Amdipharm
and roadside assistance provider RAC. Both are solidly
performing UK companies which are looking to return some
cash to their equity investors. In the case of Amdipharm by
a straight dividend to Cinven; whilst Carlyle have sold half
of their stake in RAC to the Singaporean investor GIC. Both
issuers are looking to place significant GBP tranches with
margins of L+475 and an OID in the 99 area. Amdipharm’s
EUR denominated tranche is talked at E+425.
High Yield
Henry Craik-White
Senior Investment Analyst
The selloff in global risk assets accelerated this week.
Spreads on cash bonds in the Merrill Lynch H9PC index
widened by 37bps and the iTraxx Xover CDS index
outperformed, with spreads widening by 26bps.
The Ebola outbreak has added an additional layer of
volatility to the market with the travel and leisure sectors
particularly impacted. High yield names which have sold
off include travel agent, Thomas Cook, airport duty free
retailer, Dufry and German airline, Lufthansa, with bond
prices falling between two to eight points. As the number of
cases continues to rise in West Africa, the risk remains that
isolated cases will be seen in the developed countries.
Company earnings were dominated by the consumer
sector which has seen slightly less volatility this
week compared to September, when it significantly
underperformed. UK clothing retailer, Matalan, reported
better than expected numbers as it bolstered its margins
ECM Credit Market Summary
through reduced markdowns. Its policy to hold less
inventory is paying dividends and despite a very tough
September, due to the unseasonably warm weather, it held
full year guidance. Its bonds responded well rising three
points. France has generally been a difficult territory to
operate in as the economy struggles to expand. Despite
this, French electrical and furniture retailer, BUT, and food
manufacturer, Labeyrie, reported good numbers. BUT saw
revenues and profitability grow by 6% and 34% respectively
and Labeyrie reported similar revenue growth and 11%
improvement in profits. BUT has seen current trading
over the summer improve following the disruption caused
by the football world cup and Labeyrie is experiencing
good revenue growth as it continues to recover input cost
inflation.
It was a difficult week for various credits in Italy. In the
gaming sector, Snai, saw its bonds slide nine points
after the government announced proposals to increase
5
taxes and reduce gaming machine payouts. Competitor,
Gamenet is likely to be the most impacted and its bonds
fell six points. Telco, Wind, has seen its sub bonds fall
ten points over the past ten days as local press reports
have stated that the near-term consolidation of that
market is unlikely. Clearly consolidation would benefit
the market but 3 Italia and Wind need to move closer,
in terms of a potential deal structure and price. Facility
management provider, Manutencoop, announced it was
under investigation by the Italian competition authority
with respect to a recent contract win. This is in addition
to the news over the summer that various members of
its senior management team are also being investigated
for other alleged improper practices. The market did not
take the news well, initially sending its bonds down twenty
five points. Its bonds then recovered twenty points after
the company hosted a conference call for investors which
confirmed the downside was limited and that it had bought
back bonds in the open market.
On the M&A front, cinema operator, Vue, announced it had
agreed a deal with Mediaset to acquire its Italian cinemas
for €105m. It is expected that the deal will be part funded
with an equity contribution from its owners, OMERS and
AIMco, leaving credit metrics broadly unchanged.
There were no new issues this week.
Sovereigns & Financials
Satish Pulle
Head of Financials & ABS
Sovereigns
The Italian and French governments seem to be heading
into a confrontation with Germany and the ECB over
their budget deficits and further structural reforms. Both
governments face political hurdles to reform. The same
applies to Greece, where the political dynamics highlight
austerity fatigue with the unemployment rate still being
extremely high. The ECB’s LTRO programme and OMT
announcement provided governments two years’ relief from
bond market pressures – unfortunately, this window has
only partially been used, and there remains a substantial
unfinished agenda of economic reform.
Financials
The price of Cocos were lower this week, with the Bank of
America Merrill Lynch Coco index widening some 144bps,
compared with 8.5bps widening last week. By comparison,
the EURO STOXX banks equity index was down nearly
4.5% over the same period. Peripheral bank bonds were
particularly weak across the capital structure as concerns
re-emerged not only about the state of their economies but
also about the forthcoming ECB stress test results due in
two weeks’ time. Greek bank debt was under pressure as
investors took a dim view of the possibility of the Greek
government deciding unilaterally to opt out of the IMF
ECM Credit Market Summary
Robert Montague
Senior Investment Analyst
programme early. Short-dated Greek bank senior bonds
were all 3-4 points lower on the week and now trade with
an average yield of 8% compared with a 4% average
at issue this summer. Subordinated debt from weak
German Landesbanks was under pressure as investors
fretted about how they would fare in the stress tests; HSH
Nordbank Tier 1 paper fell by 5 points this week to trade
in the low thirties range having traded as high as 50 cents
in the summer whilst the NDB 6.25 24 Tier 2 bond drifted
lower this week to trade around 90 cents having been
issued at par in late March.
On a more positive note, Bank of China was able to
successfully launch its huge inaugural $6.5bn Additional
Tier 1 bond. This was the biggest Coco issue to date
beating HSBC’s previous $5.6bn dual tranche deal last
month. However, the Bank of China issue was very much
an Asian affair with 96% of the orders coming from the
region despite an extensive road show in Europe. The
bonds held up well given the difficult market conditions,
trading above par initially, no doubt helped by the 25 cents
concession given to private banks, which accounted for
29% of the orders. We feel the 6.75% coupon on the bond
was not particularly generous given signs of a significant
slowdown in the Chinese economy and signs of a bursting
of the property price bubble.
6
Asset-Backed Securities
Maddi Rowlatt
Asset Class Specialist, ABS
The overriding theme in the market continues to be “wait
and see, for the ECB”. The difficult week for wider markets
did not feed into the entire ABS market immediately, but
we have seen some volatile moves in peripheral ABS
with senior paper out by up to 20bp. The main players in
this paper currently are fast money and the street which
appears relatively heavy with this paper given the known
exit via ECB purchases, at some point. So, some volatility,
with no firm idea of when the ECB will start buying is
understandable. The softening did, however, move into
core asset classes, with UK prime and Dutch senior
widening over the past couple of days. These moves
are not large price moves but Dutch AAA are out 5-10bp
in spread terms. Mezzanine assets however, seem well
supported by the largely firm real money investor base and
a better technical market.
On a brighter note, the primary market held up well with a
number of ABS placed with investors, albeit in core asset
classes, UK Credit cards, European Autos ABS, and UK
RMBS were all placed with investors this week, with senior
and some mezzanine paper sold. Two of those transactions
were backed by recently acquired UKAR collateral. Some
unusual structural features of these deals led to wider
pricing than comparables.
Finally, investors in LORDS1 CMBS were left perplexed
when, on Friday, S&P unexpectedly withdrew its ratings on
the transaction without any apparent communication with
the borrower or the issuer. It later transpired that the ratings
withdrawal was due to a technical glitch within S&P’s
systems and the ratings were duly reinstated later in the
day.
Emerging Markets
Duncan Warwick-Champion
Co-Head of Global Credit Research
President Vladimir Putin met with European leaders
in Milan on 7 October to discuss the ongoing crisis in
eastern Ukraine. David Cameron described the talks
as positive and stated that Putin had denied that the
Russian government wants to see a frozen conflict as
the long-term outcome of the current situation in the
Donbass. However, a spokesman for the Kremlin later
stated that “unfortunately, some participants of [the talks]
demonstrated complete unwillingness to understand
the reality in south-eastern Ukraine”. The Ukrainian and
Russian governments agreed a peace plan in Minsk in
September that was supposed to involve a ceasefire
between Ukrainian and pro-Russian forces. Clashes
nevertheless continue – particularly around Donetsk
airport.
The economic pressure that Western sanctions are placing
on the Russian economy continues to translate into a
weaker rouble, with the currency this week hitting new alltime lows against the Bank of Russia’s dollar/euro basket.
The central bank’s interventions to protect the currency
ECM Credit Market Summary
from shaper falls now total US$11bn since the start of
October and US$52bn since the start of the year. Recent
declines in oil prices certainly provide a further headache
for Russian policymakers trying to protect the rouble’s
value. The five-year CDS on the Russian sovereign ends
slightly weaker on the week at 260bps.
Elsewhere in Emerging Europe, Romanian policymakers
continue to suggest that the country will seek to sell eurodenominated debt before the 2 November presidential
elections. Budget Minister Darius Valcov said that the
government aims to sell at least €1bn of Eurobonds in
order to pre-finance 2015 – Romania has a €1bn bond
maturing next year. Romania should not have any problem
in raising new funds from the market, despite recent
volatility, given the dramatic change in investor sentiment
towards the country that has occurred over recent years.
Five-year CDS on the sovereign hit a high of 490bps in
2012, but now trade at just 160bps.
7
ECM Market Monitor
As at 16 October 2014
CREDIT MARKETS*
1WK
MTD
2014 YTD
2013
Source
EURO CORPORATES
-0.11%
0.07%
1.95%
2.72%
BofA ML ER00
EURO IG FINANCIALS
-0.18%
0.04%
1.99%
3.24%
BofA ML EB00
EURO HIGH YIELD
-1.39%
-1.36%
0.17%
9.95%
BofA ML HE00
STERLING NONGILTS
-0.75%
-0.68%
1.17%
4.63%
BofA ML UN00
STERLING IG FINANCIALS
-0.90%
-0.91%
1.35%
7.47%
BofA ML UF00
US CORPORATES
-0.48%
-0.59%
1.12%
2.86%
BofA ML C0A0
US IG FINANCIALS
-0.43%
-0.45%
1.15%
4.07%
BofA ML CF00
US HIGH YIELD
-1.90%
-2.54%
-1.05%
9.19%
BofA ML H0A0
EURO LOANS
-0.54%
-0.62%
2.21%
9.63%
S&P Euro denominated ELLI*
1WK
MTD
YTD
2013
Source
FTSE 100
-3.66%
-6.40%
-5.25%
19.05%
UKX INDEX
S&P 500
-3.37%
-5.47%
2.41%
32.37%
SPX INDEX
NIKKEI 225
-4.78%
-8.87%
-8.20%
59.37%
NKY INDEX
1WK
MTD
YTD
2013
Source
-6.20%
-10.77%
-23.76%
-0.28%
CO1 COMDTY
1.19%
2.54%
2.75%
-28.04%
GOLDS COMDTY
1WK
MTD
YTD
2013
Source
USD
0.93%
1.41%
-6.80%
4.17%
EURUSD CURNCY
GBP
1.12%
2.20%
-4.10%
2.26%
EURGBP CURNCY
JPY
-0.47%
-1.65%
-5.89%
26.45%
EURJPY CURNCY
1WK
MTD
YTD
2013
Source
US 10YRS
1.38%
2.93%
8.64%
-5.92%
ITRR7T10 index
GILTS 10YRS
1.52%
2.84%
9.38%
-5.08%
QX6I index
BUNDS 10YRS
0.54%
0.83%
10.94%
-1.60%
QW3Q index
US SWAP 10YRS
1.39%
3.23%
10.12%
-7.64%
U10C
EURO SWAP 10 YRS
0.31%
0.57%
12.84%
-2.81%
E10C
STERLING SWAP 10YRS
1.73%
3.13%
10.58%
-6.65%
S10C
1WK
MTD
YTD
2013
Source
ITRAXX MAIN
-0.52%
-0.39%
0.92%
4.04%
ERIXITEU index
ITRAXX CROSSOVER
-2.42%
-2.38%
4.41%
17.79%
ERIXITXO index
EQUITY MARKETS
COMMODITY MARKETS
BRENT OIL
GOLD
CURRENCY MARKETS VS EUR
Asset-Backed Securities
RATES MARKETS
CDS MARKETS
ECM Credit Market Summary
8
ECM in the Media
Recent articles
13 October
I should CoCo?
Portfolio Institutional
13 October
German sub bonds rocked by threat of stress test failures
International Financial Review, Reuters
10 September
ECM involvement leaves investors grappling with low returns
Capital Structure
02 October
CLOs: The Comeback Kings
International Financing Review (IFR), Hedge Fund Insight
01 October
Solvency II drives insurers into sub-bond market
Reactions
29 September
Junk-Bond rout amplified bt Gross exit as sales expected
Bloomberg
Click here to view ECM’s press archive
ECM Credit Market Summary
9
ECM Asset Management Limited
34 Grosvenor Street, London W1K 4QU
Tel: +44 (0) 20 7529 7400
Fax: +44 (0) 20 7529 7411
ECM, Wells Fargo Asset Management and WFAM are
trading names of ECM Asset Management Limited which
is authorised and regulated by the Financial Conduct
Authority
This document may be distributed only to persons permitted to
receive it under applicable law and may not be distributed or
passed to any person in any jurisdiction in which such distribution
would violate any applicable law.
This document is:
This document may not be distributed other than: (1) within the
USA, to investors that are Accredited Investors within the meaning
of Regulation D under the U.S. Securities Act of 1933; and (2)
outside the USA, to non-US persons in offshore transactions in
reliance on Regulation S under the U.S. Securities Act of 1933.
• issued by ECM for information only;
• not investment advice;
• confidential and should not be disclosed other than to your
professional advisers; and
• directed at persons (“Investment Professionals”) having
professional experience in matters relating to investments, and
any investment or investment activity to which this document
relates is available only to and will be engaged in only with
such persons.
If you are not an Investment Professional you should not read this
document or participate in any meeting or other communication
relating to it.
ECM accepts no liability for and gives no warranty or guarantee
and makes no representation relating to the performance of any
investments referred to in this document or to the accuracy and/or
completeness of the information contained in this document. Any
information contained in this document relating to any securities
or issuer thereof is subject to the offering document relating
thereto and does not constitute an offer to sell, or a solicitation
of an offer to purchase, interests in the funds. Such an offer or
solicitation can only be made pursuant to the applicable offering
document, and any summaries contained herein are qualified
in their entirety by reference to the more detailed discussion
contained in each such offering document.
ECM and its affiliates do not provide tax advice. Please note
that: (1) any discussion of tax matters contained in this document
(including any attachments) cannot be used by you for the
purpose of avoiding tax penalties; (2) this document was written
to support the promotion or marketing of the matters addressed
herein; and (3) you should seek advice based on your particular
circumstances from an independent tax advisor.
• Investments offered in the U.S. by Wells Fargo Funds
Distributor, LLC, Member FINRA/SIPC, Wells Fargo Funds
Distributor, LLC. and ECM Asset Management Limited are
affiliates of Wells Fargo & Company.
• NOT FDIC INSURED - NO BANK GUARANTEE - MAY LOSE
VALUE PAST PERFORMANCE IS NOT NECESSARILY
INDICATIVE OF FUTURE RESULTS.
ECM is authorised by the Financial Services Board of South
Africa as a Financial Service Provider.
228402 101714
Sources:
Author photographs: MeltingPot Pictures
ECM Credit Market Summary
10