17th January 2018

CoCos are the must-have product

MARKET CLOSE:
iTraxx Main

44.2bp, -0.3bp

iTraxx X-Over

232.5bp, +1.7bp

10 Yr Bund

0.56%, unchanged

iBoxx Corp IG

B+89.7bp, -0.5bp

iBoxx Corp HY

B+274.5bp, +0.5bp

10 Yr US T-Bond

2.57%, +3bp

FTSE 100 , DAX , S&P 500 ,

Designed to fail, but who cares…

A steady day – which saw risk assets slightly better offered, but amid the excellent performance already in these opening New Year sessions coming from the contingent convertible bond market, we had the first foray into the primary market by a borrower. We suggested in yesterday’s comment that we needed a deal, and Raiffeisen Bank International duly obliged.

RBI fed into the considerable demand for AT1 risk with a €500m PNC7.5 AT1 issue priced to yield 4.5% – 50bp lower than the initial guidance, on books in excess of €4bn. The sector’s performance allowed the borrower to print with a coupon over 200bp lower than its last AT1 offering just 7 months ago. Nordea currently holds the record for an AT1 offering with the lowest coupon (3.5%), but a higher quality borrower than RBI (and closer to Nordea) will be looking to issue nearer to the 3% coupon level.

It makes sense. Fundamentally, the banking sector is on the up. The macro outlook is bright and the banks’ credit quality is improving. We’re in the sweet spot of the current cycle for the demand for bank subordinated risk and the compression trade (senior versus subordinated debt) is on. That compression has seen the CoCo index spread versus the senior bank debt index drop from 860bp two years ago to 235bp now! In the last 12 months, it has fallen from 548bp to 235bp. Judging by the (now year-long) sustained momentum for CoCo risk, this compression has some way to go.

We think the AT1-senior bank debt spread differential can get to 150bp soon enough. It will be pushed in part by the expected level of issuance of just €25-30bn for this year not being enough to satiate demand. In addition, the RBI book being 8x subscribed is some early evidence for that demand. More deals will only add to the confidence levels investors have – and that means tighter spreads.

The CoCo Markit iBoxx index is 50bp tighter this year and returns are up 1.8%. Rates might be going slightly higher, but the demand for higher yielding risk is well intact nevertheless. That hasn’t quite fed into the corporate high yield market, where the technicals and spread levels are not as attractive versus contingent convertibles. In a financial crisis, the pay off will be quite different, admittedly. By way of comparison, the IG-HY spread compression has seen the spread differential move from 276bp last January, to 184bp now. We’ve only has 6bp compression in the opening fortnight of 2018.


Primary’s trio of firsts

The new issue market was again fairly busy but unfortunately inundated with deals from the SSA and covered bond sectors. Investment grade non-financial issuance drew a very surprising blank with no follow-up to the €15bn+ of deals seen thus far this year.

We had a few firsts, though. In sterling, Dwr Cymru Welsh Water issued £300m at G+80bp in a long 18-year maturity deal and became the first IG non-financial borrower of the year in this currency. Zoopla’s sterling high yield deal was the only other non-financial sterling deal until Pure Gym printed £360m in a 7NC3 to yield 6.375%.

The trio of ‘sector’ issuance firsts was completed (the other being the CoCo from RBI) as German real estate group Summit Germany issued an upsized €300m in a 7NC3 structure priced to yield 2%. So the high yield account is finally open, and we think others will pull the trigger on deals this week still.

In senior financials, Barclays was in through it’s holding company with a €1bn 8NC7 deal priced at midswaps+78bp (-12bp versus IPT) off a €2bn order book, and took the senior supply issuance to €17.4bn for the year.


US market relentless rise continues

The losses from Tuesday’s session proved fleeting for US equities because the relentless rise in markets continued. The Dow visited 26,000 again while the S&P shot through 2.600 (again). Europe failed to push on at all in the session, playing out in the red right through it with bourses closing up to 0.5% lower.

The Fed’s Beige Book assessment of the US economy for 2018 was extremely positive for the corporate sector largely on those tax reforms. In to the close, all the US indices were over 1% higher and it has to auger well for European markets on Thursday (as they play catch up).

Also fleeting, was November’s surprise pullback in US industrial production, which saw December’s 0.9% smash expectations of 0.4%. There was little else in the markets although Bitcoin fell below $10,000 in the session. It’s back over again at time of writing, though. Rates markets were largely unchanged leaving the 10-year Gilt to yield 1.31%, the equivalent maturity Bund 0.56%, while US Treasury yields backed up to 2.57% (+3bp).

We had a bit of a mixed session in synthetics, with Main better offered (lower), for choice, and at 44.2bp (-0.3bp) with X-Over better bid at 232.5bp (+1.7bp), but the moves were small enough to suggest that it was really all a bit of noise.

In the cash market, the Markit iBoxx IG cash index saw fresh records, as the index squeezed to B+89.7bp (-0.5bp) likely driven in large part to the lack of issuance while demand for corporate bonds remains elevated as always so early into any New Year. In single names, Carrefour issued a profits warning for 2017, and we might see some follow though in the CDS market on Thursday, although we don’t think anything will happen in cash.

As for high yield, the market followed the directionality seen in X-Over with little else to help provide any colour. The cash index edged wider to B+274.5bp (+0.5bp).

Have a good day.


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Suki Mann

A 30+ year veteran of the European corporate bond markets and in his role as Credit Strategist, Dr Mann has been ranked number one in the Euromoney Investor Survey eight times in ten years. Previously with Societe Generale and UBS, he now shares views of events in the corporate bond market exclusively here on CreditMarketDaily.com.