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Credit
Market
Summary
21 November
2014
Portfolio
Commentary
Outlook for rates
over next year
Alastair Thomas
Head of Rates & Treasury
Although many shorts were finally squeezed out by the
mid-October spike in treasury prices investors tend to still
be either short or neutral to benchmarks. This is supported
not only by position reports but also by economists’ views
of considerably higher rates for the end of next year. For
example, the Bloomberg survey of economists indicate
average yields for 10 year treasuries at the end of 2015
are expected to be as follows: US 3.23%, Germany 1.44%
and UK 3.19%. These compare to implied forward yields
of about US 2.66% (currently 2.34%), Germany 0.98%
(currently 0.80%) and UK 2.38% (currently 2.10%). The
higher yield expectations may continue to be thwarted if
positioning is still short or neutral. Further capitulation
and a decent treasury long position being established will
really help a proper treasury sell-off. I must admit that I
have highlighted all year the potential for higher rates in the
US and UK driven by expectations of strong US and UK
growth and rapidly declining unemployment. This drove
our key trade ideas: US and UK yields higher and widening
to bunds, curve flattening and front end Eurodollar
steepeners. Although decent returns have been made
on these trades by picking good entry/exit levels I have
subtly changed my outlook which I explain below. I expect
rates at the end of next year to be considerably below the
consensus economist estimates even if possibly higher
than current levels.
First a quick review of the mid-October volatility. The
Fed’s thinks it was “driven primarily by concerns about
prospects for foreign economic growth”. However a
few sentences later they do say that “further pockets
of turbulence were likely to arise as the start of policy
normalization approached”. That second comment is a
much more relevant explanation. In September the Fed
member’s forecasts for rates as shown in the famous
“dot” chart moved considerably higher. This helped push
the USD higher and stocks started falling perhaps due to
fears that the Fed would choke off growth with too rapid
rate rises. The minutes for the September FOMC meeting
then showed the Fed were concerned the appreciation of
the dollar could have an adverse effect on the US external
sector. Investors became confused about how the Fed
ECM Credit Market Summary
would proceed especially as members gave often confused
messages. For example, Bullard said on the 9th October
that inflation would go above the Fed’s 2% target in 2015
and that he was not worried about dollar strength and
that rate hikes should start in Q1 2015. The same Bullard
then said on 16th October that the Fed should consider
delaying the end of QE purchases (but that he was nervous
about rates staying at zero as the economy improves).
The confused market dumped stocks and moved into safe
haven treasuries.
The “foreign economic growth” to which the Fed refers
is likely the continuing stagnation in the Eurozone and
concerns about China with its property price declines and
growing non-performing loans. Chinese growth will likely
be less than this year and possibly around as much as
1% lower (closer to 6% than 7%). However, it is possible
the Chinese will manage to engineer the growth they
target as they often do but they are likely to be concerned
about the strength of the USD as the yuan is closely tied
to it. The Chinese could escalate the currency wars and
try to weaken the yuan as in early 2014 to help export
driven growth. This would likely push USD yields lower
as the Chinese move into USD and invest in treasuries
maintaining the yield curve flattening bias.
My outlook for inflation has changed thus tempering my
rates outlook. I have generally believed this year that
unemployment would fall in the US and UK (which it has)
and this would fuel consumer spending and help drive
inflation higher. However, commodities, especially oil, are
keeping downward pressure on prices. It will take time for
the low oil prices, if maintained, to flow through to CPI data
and this will counter any wage led inflation. The issue is
whether the decline in oil is due to a sustained reduction in
demand due to global growth concerns (it is less likely to
be related to supply as that has been increasing for the last
few years and it is only in the last few months the price has
suddenly declined). In the US the resultant fall in the price
of gasoline saves the average household approximately
$900 per annum. This provides a boost to disposable
income that can be spent on additional goods. This growth
2
stimulus is likely to be a short lived even if oil prices remain
low. The flipside is that the US economy is reliant to a
large degree on the energy sector which has been a major
boost to employment. The recent Fed rhetoric shows they
recognise the risks of low inflation but they feel it will not
persist and that inflation will get back to the 2% target in
“the next few years”. Likewise the BoE sees risk of inflation
dipping below 1% in the next six months but reverting to
target by 2017. I do still expect unemployment in the US
and UK to continue to decline towards full/equilibrium
employment levels over the next year. However, if inflation
were to stay low or go even lower what will the central
banks do? They have mandates that include fostering
employment and price stability and I suspect they will defer
rate hikes if inflation remains low due to their greater fear of
deflation.
“ I expect rates at the end of
next year to be considerably
below the consensus economist
estimates even if possibly
higher than current levels. ”
I have focused so far on US and the UK only to highlight
the risks that might delay the rate hikes that are still priced
to happen later next year. In the Eurozone there are no
rate hike expectations and the German bund curve is
fully priced for deflation and low growth with bonds out to
four years at or below 0% yield. Indeed the German and
Japanese yield curves are virtually the same out to five
years. Japan has endured 20 years of deflation and yet
five year Japanese yields only hit 0% once (in 2013). The
dire prospects for the Eurozone might change if the ECB
act soon with proper QE (only because that seems to lift
asset prices, weaken the currency, stave off deflation and
improve confidence rather than actually create jobs). Talk
is cheap and eventually the market’s patience will wear
out. There is a therefore a risk that UK growth is dragged
by the Eurozone and thus UK rate hikes might be delayed
(potentially widening UK versus US yields further). Yields
for longer maturity bonds could be kept low by reduced
term premia as a result of Japanese QE and also ECB
QE if it takes off. That could help flatten the yield curves
further.
In summary, although the market is pricing a slower pace
of rate hikes in the US than the Fed we may yet see lower
rate expectations for the US and UK (as we did temporarily
in October). I expect the US and UK curves to continue to
flatten. We could see continued bull flattening with longer
maturities being bought as China tries to weaken the
yuan or Japanese, and possibly ECB, QE drive investors
into treasuries. Alternatively inflation expectations might
continue to fall and therefore delay rate hikes in the US
and UK. Of course, bear flattening could at times be reestablished with shorter end rates being pushed up on
strong US and UK economic data with buyers still looking
to buy longer maturity bonds on price dips. I see no reason
that 2s10s will not continue the current pace of flattening
in which case the US swaps curve could be around 70bps
by the end of 2015 compared to the current 170bps (or
some 50bps below forwards). Clearly there could be bouts
of steepening if inflation looks like it is picking up and that
central banks will be behind the curve in hiking or because
the market believes that any ECB QE will finally lead to
Eurozone growth and inflation. There are also increasing
concerns about the potential for some shock occurring
(perhaps a large escalation in the Ukraine conflict) and
this will maintain a degree of safe haven treasury bid.
Volatility will also likely increase due to poor liquidity,
low investor confidence in positions and with traders risk
appetite reduced due to October’s volatility. This volatility
will provide opportunities for additional rates trading alpha
generation.
2s10s US swaps
2.7
2.5
2.3
2.1
1.9
1.7
1.5
Source: Bloomberg
ECM Credit Market Summary
3
Investment Grade
Corporates
Rhys Foulkes
Investment Analyst
After a hectic earnings season, IG credits took a breath
this week, with HY analysts taking on the earnings mantra.
This was reflected in spreads as the MAIN CDS index
was unchanged to a basis point wider at 64, and cash a
basis points wider at 93 for ER00. There was a little new
issue activity, with 2i RETE GAS S.p.A. launching a new
deal this morning and ISS holding a roadshow ahead of a
two tranche deal next week. High quality issuers like IBM
and AstraZeneca were in the market, but the main new
issue news came from the USA/Asia as Alibaba launched
a 6-tranche dollar deal, raising $8bn in total from an order
book north of $50bn. The bonds opened c5bp tighter.
In credit specific news, there were a few of laggards
reporting earnings such as ThyssenKrupp with strong FY
results as EBITDA almost doubled to €2.3bn and Centrica
lowering their 2014 guidance following weather-related
challenging trading conditions. Vivendi, reported strong
Q3 earnings growth and reduced net debt on divestments,
but the main earnings news came from Areva as they
suspended their financial outlook for 2015-16. The decision
was due to the deterioration of the environment in which
the company operates (revision of reactor new-build
schedules, recycling export contracts and international
projects and a lacklustre market for installed base services)
as well as some Areva-specific issues. S&P downgraded
the credit to BB+ from BBB- following the announcement.
As earnings news took a back seat, M&A related headlines
came back to the fore especially in the telecoms and
utilities space. Firstly Telecom Italia denied they are
considering a possible capital increase to fund a merger
of TIM Brasil and Oi, but this did not stop potential merger
rumours. Telefonica is said to be considering their options
for various parts of the portfolio, including selling their UK
unit and participating in Brazilian consolidation, Deutsche
Telekom expects T-Mobile to attract potential suitors again,
and Altice’s CEO claim they are the most natural buyer for
Bouygues Telecom. Within utilities, Enel confirmed that
it will receive €3.13bn for Endesa. There were also more
rumours surrounding Tesco possibly selling their business
in Thailand for $10bn, which would represent an attractive
multiple.
Staying with UK retail, Kantar reported 12-week sales
numbers to the 9th of November which showed the
grocery market as a whole declining by 0.2% as inflation
fell to -0.4%. This is the first contraction since they began
recording the series in 1994, and highlights further the
difficulties faced by UK supermarket chains.
Loans
Sam McGairl
Portfolio Manager
There is much talk of a busy new issue pipeline at the
moment but for now it remains just that. The expected
transactions for Siemens Audiology and the take private of
UK restaurant chain Prezzo have yet to launch but United
Biscuits is now being pushed into the loan market by the
arranger HSBC. Investors will attend a meeting today for
the £985m loan which will feature both GBP and EUR
tranches aimed at institutional investors. Recent large
GBP loans for Amco and RAC have struggled somewhat
in primary and been forced to raise pricing prior to close.
United Biscuits is said to be starting with pricing north
of L+500 to reflect the new reality although it should be
helped by being a long time loan issuer with a strong CLO
following. Exiting the new issue market this week were addon loans for Bartec and Endemol, as well as the refinancing
ECM Credit Market Summary
of UK clothes retailer Fat Face. The latter transaction,
which was an underwritten loan to finance a dividend to the
sponsor Bridgepoint after a failed IPO earlier in the year,
struggled to attract investors so ended up printing at a price
of 93 on the senior loans and 75 on the second lien.
The secondary market has maintained the recent firm tone
this week with buyers looking to fill CLO warehouses and
replace exposures which are repaying. On Wednesday
the loans for Firth Rixson repaid as the purchase of the
company by Alcoa completed. Loan investors are expecting
multi billion euro equivalent repayments from TDF and
Alliance Boots in coming weeks but as yet timing on these
is unclear, as is the extent to which the proceeds will be
reinvested or returned to CLO 1.0 investors.
4
High Yield
Henry Craik-White
Senior Investment Analyst
The high yield market remains dislocated from the positive
trends seen in the equity markets. Spreads on cash
bonds in the Merrill Lynch H9PC index widened 6bps and
the iTraxx Xover CDS index matched this, with spreads
widening by 6bps.
Once again it was a busy week for earnings news, which
was the principle driver of volatility for riskier credits that
disappointed. UK insurance broker, Towergate, generated
the most extreme price action as it announced earnings
earlier than expected, which were weak. It reported that
profits had fallen by 19% and that its liquidity and covenant
headroom would significantly diminish over the coming
quarters. Towergate also disclosed that it had received
expressions of interests to acquire the business. The
trading and liquidity news implied the directors were guiding
the market to the fact that a balance sheet restructuring
was a strong possibility and this sent its junior bonds
down thirty points. Going in the opposite direction were
Spanish engineering firm, Abengoa’s bonds. Following the
collapse in prices last week over accounting disclosure,
management launched a charm offensive to meet investors
and calm nerves. This proved effective as its bonds
rebounded by twenty points. UK care home operator, Four
Seasons, saw its bonds fall nine points after appointing
Blackstone as an advisor to examine financial and strategic
options which also included a capital structure review.
However, the bonds recovered some of this lost ground
after reporting earnings, which confirmed trading was bad
but not terrible, implying the group has time to reduce
leverage before a potential debt restructuring is needed.
than the market had expected. Price pressure on new
contract wins and a stubborn cost structure are likely to
cause earnings to decline for several quarters to come.
The group is also facing the prospect of its CEO being
placed under house arrest in early December if a Supreme
Court judgement goes against him. More positively, Italian
gaming operator, Sisal and UK restaurant chain, Pizza
Express, reported good numbers which sent their bonds up
two and one point respectively.
The market is generally ahead of the game when it comes
to rating moves but the downgrade of Spanish construction
firm, OHL, by Moody’s, from Ba3 to B1 with a negative
outlook, caught it off-guard. Its bonds fell four points as the
investor perception of BB versus B risk is currently material
and the market believed this asset rich, cash poor operator
was well positioned to hold onto its BB rating.
There were two new issues this week, totalling €450m.
These came from existing issuers, German container
shipping operator, Hapag Lloyd, and communications
equipment producer, Belden. Hapag Lloyd intends to use
the proceeds to partially refinance near term maturities
and Belden is building a war chest for future acquisitions.
Spanish cured meats producer, Campofrio was due to
issue this week but a fire at one of its factories resulted in
the deal being pulled for the time being.
This week saw the outbreak of bird flu in the Netherlands
and UK. Poultry and food producer, Boparan, was the
hardest hit despite not being directly impacted at this stage.
Its bonds are down seven points on this news and also
due to weak earnings. Boparan confirmed that it expects
a weak current quarter as it invests in marketing and food
safety to fight campylobacter. Embattled Italian facility
management operator, Manutencoop, saw its bonds slide
thirteen points after reporting revenues and profits had
fallen by 10% and 32% respectively, which was worse
ECM Credit Market Summary
5
Financials
Robert Montague
Senior Investment Analyst
It feels very much like investors and traders have already
closed their books for the year with flows being light in
European financials even by today’s anaemic standards.
Cocos drifted lower on the week. Nevertheless bond
syndicates seem determined to launch a series of new
issues into an unreceptive market before the window
closes for the year. Therefore, it was no surprise that
virtually none of these deals have performed. Deutsche
Bank issued a $1.5bn 7.5% PNC10 bond (the final part of
its planned €5bn AT1 issuance programme) that was soon
trading almost a point down. Within the Tier 2 market KBC
came with €750m 10NC5 at MS+198; the bond also traded
down not helped by the fact that it was issued out of the
holdco, KBC Group, given TLAC proposals are fresh in
investors’ minds. Erste Bank was the first Austrian bank to
brave the Tier 2 market since the Austrian government’s
decision to write-off Hypo-Alpe Adria subordinated
bonds earlier this year; not surprisingly it received a
cool reception, despite being priced at the wide end of
initial price talk (5.5-5.625%) with the $500m book barely
covered by investor demand. Deals from off-the-run issuers
such as Dutch insurer ASR and Dutch Bank NIBC, which
intended to launch this week were pulled given the general
investor apathy towards new issues. Cardif, BNP Paribas’
insurance subsidiary, launched its maiden subordinated
deal this but despite strong domestic demand for French
insurance paper, €1bn issue ended the week marginally
below re-offer level, reflecting the general malaise in the
new issue market.
Asset-Backed Securities
Maddi Rowlatt
Asset Class Specialist, ABS
The ECB published the legal act for the long awaited ECB
ABS PP on Thursday. The market expected purchases
to begin the day after publication but there is no sign of
activity from the asset managers appointed to buy, just yet.
The document laid out a few extra criteria, mentioning that
CMBS would be included in the programme if at least 95%
of collateral is Euro denominated and 95% of the properties
are located in the euro area. These requirements, in
addition to loan by loan reporting, which include true sale
and no inclusion of structured loans in the pool mean that
no outstanding CMBS are currently eligible. The issue
of public (non ECB) participation in retained tranches of
ABS was mentioned but without a specific percentage
of the tranche that would need to be bought external to
the originator or the ECB. The market remains subdued
in secondary flows but BWIC activity has been relatively
strong this week with both eligible and non-eligible bonds
trading well.
ECM Credit Market Summary
In primary, price guidance for Arena NHG 2014-II, a Dutch
RMBS from Delta Lloyd will be announced next week
along with Auburn, 8, a UK buy to let RMBS from Capital
Home Loans and SUNRI 2014-2, an Italian ABS from Agos
Ducato. The time for any further deals being announced
and priced this year is very slim so we are unlikely to see a
large amount of further new issuance.
6
Emerging Markets
Rhys Foulkes
Investment Analyst
The surprise upset in Romania’s Presidential election last
weekend was warmly welcomed by credit markets. Against
opinion polling and the first-round result the centre-right
candidate, Iohannis Klaus, defeated Prime Minister Viktor
Ponta to become the country’s fifth president since the
1989 revolution. The Presidency has control of foreign
relations, defence policy and controls the appointment of
the judiciary – Iohannis’ campaign focused on his promises
to strengthen the judiciary and stamp out corruption, an
endemic problem in Romania. Defeated candidate Viktor
Ponta, of the centre-left Social Democratic Party, will
remain as Prime Minister and has pledged to work with the
President on his anti-corruption agenda – a draft bill that
would have freed several politicians jailed for corruption
has already been scrapped. Both candidates also support
the standby-arrangement with the IMF, which has proved
an anchor for macroeconomic policy through recent years.
Romania’s improving macroeconomic fundamentals,
combined with this positive surprise on the political side,
has seen credit spreads continuing their two-year long
ECM Credit Market Summary
compression with the Z-spread on Romania’s 2024 2.875%
euro-denominated bond falling to 162bps, from 188bps
when it was issued in October.
Romania also saw particularly strong economic growth in
the third-quarter of 2014, according to data released last
week. Real GDP rose 1.9% q-o-q following weakness in
the first half of the year. Conversely, most other countries
in the region saw a modest slowdown in economic activity.
Poland’s real GDP grew 3.3% y-o-y in Q3, compared to
a 3.5% expansion in Q2, and Hungary saw 3.2% y-o-y
growth, from 3.9% in Q2. Russia posted the region’s
weakest pace of growth, at 0.7% y-o-y, and continued
deterioration looks likely as sanctions undermine both
consumption and investment. As such, it is understandable
that Russian credit remains weak – the spread on the
sovereign’s 2030 dollar bond briefly touched a three-year
high this week.
7
ECM Market Monitor
As at 20 November 2014
CREDIT MARKETS*
1WK
MTD
2014 YTD
2013
Source
EURO CORPORATES
-0.17%
-0.02%
2.14%
2.72%
BofA ML ER00
EURO IG FINANCIALS
-0.18%
0.01%
2.26%
3.24%
BofA ML EB00
EURO HIGH YIELD
-0.32%
0.34%
2.05%
9.95%
BofA ML HE00
STERLING NONGILTS
-0.27%
-0.37%
0.77%
4.63%
BofA ML UN00
STERLING IG FINANCIALS
-0.26%
-0.20%
1.38%
7.47%
BofA ML UF00
US CORPORATES
-0.35%
-0.69%
0.53%
2.86%
BofA ML C0A0
US IG FINANCIALS
-0.23%
-0.32%
1.02%
4.07%
BofA ML CF00
US HIGH YIELD
-1.00%
-1.28%
0.40%
9.19%
BofA ML H0A0
0.05%
0.17%
2.84%
9.63%
S&P Euro denominated ELLI*
1WK
MTD
YTD
2013
Source
FTSE 100
0.76%
2.44%
2.69%
19.05%
UKX INDEX
S&P 500
0.71%
1.90%
13.10%
32.37%
SPX INDEX
-0.53%
5.40%
7.87%
59.37%
NKY INDEX
1WK
MTD
YTD
2013
Source
BRENT OIL
1.81%
-7.61%
-28.40%
-0.28%
CO1 COMDTY
GOLD
2.70%
1.74%
-0.98%
-28.04%
GOLDS COMDTY
1WK
MTD
YTD
2013
Source
USD
0.50%
0.11%
-8.76%
4.17%
EURUSD CURNCY
GBP
0.63%
2.05%
-3.75%
2.26%
EURGBP CURNCY
JPY
2.64%
5.37%
Asset-Backed Securities
2.43%
26.45%
EURJPY CURNCY
1WK
MTD
YTD
2013
Source
US 10YRS
0.06%
0.14%
7.37%
-5.92%
ITRR7T10 index
GILTS 10YRS
0.66%
1.21%
9.34%
-5.08%
QX6I index
BUNDS 10YRS
0.02%
0.42%
11.23%
-1.60%
QW3Q index
US SWAP 10YRS
0.16%
0.40%
9.12%
-7.64%
U10C
EURO SWAP 10 YRS
0.05%
0.79%
14.00%
-2.81%
E10C
STERLING SWAP 10YRS
0.76%
1.64%
10.98%
-6.65%
S10C
1WK
MTD
YTD
2013
Source
ITRAXX MAIN
-0.04%
0.08%
1.66%
4.04%
ERIXITEU index
ITRAXX CROSSOVER
-0.55%
-0.15%
6.83%
17.79%
ERIXITXO index
EURO LOANS
EQUITY MARKETS
NIKKEI 225
COMMODITY MARKETS
CURRENCY MARKETS VS EUR
RATES MARKETS
CDS MARKETS
Sources: Bloomberg, BofA ML, JPMorgan, Standard and Poors
* Credit market returns are excess returns vs. swaps with the exception of S&P Euro denominated ELLI
For stocks and indices, the key assumptions are:
1) Dividends are reinvested into the stock or index
2) Total return is in local currency
3) Net dividend is used as default for UK equities and funds.
Gross dividend is used for all other securities
ECM Credit Market Summary
8
ECM in the Media
Recent articles
19 November
ECM targets €750 million for new infrastructure debt fund
Creditflux
19 November
Riskiest Junk Borrowers Imperiled as Borrowing Costs Jump
Bloomberg
19 November
ECM seeks to exploit European infrastructure market gap with debt fund
Portfolio Adviser
19 November
Wells Fargo unit to launch Europe infrastructure fund, target $1 bln
Reuters, Les Echos/Bourse, Reuters UK, Fidelity, Global News, Venture Capital Post,
CityNewsLine.com, Today Online
19 November
ECM launches European infrastructure debt fund
Citywire Wealth Manager
18 November
Big banks find strong appetite for coco bonds
Financial Times
04 November
Apple said to plan first bond offering in Euros
Bloomberg, Bloomberg Businessweek
31 October
RAC flexes as investors exploit market weakness
Global Capital
24 October
Markets punch drunk
Investment Europe
24 October
EDreams plunges after Iberia, British Airways halt ticketing
Bloomberg
24 October
European markets show signs of stress
Wall Street Journal, NASDAQ, Capital.gr, ADFVN, Markets Spectator
22 October
European stocks jump as ECB mulls buying corporate bonds
The Wall Street Journal, NASDAQ
Click here to view ECM’s press archive
ECM Credit Market Summary
9
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ECM Credit Market Summary
10