Investment grade firms face tough battle as yield fight rages

Fri Jan 17, 2014 6:43am EST

* Triple B peripheral names are top investor picks

* Strategists call corporate bond yields "unnervingly low"

* Investors demand longer maturities

* Hybrids offer key competition for senior paper

By Josie Cox

LONDON, Jan 17 (IFR) - High-quality European corporate credits will be forced to offer juicier premiums and longer maturities on new bonds in order to compete with higher yields available from weaker names.

With many investors preferring to chase returns by going down the credit spectrum, better rated issuers are finding it increasingly challenging.

"The problem is that we're in a very risk-on environment at the moment," said Markus Steilen, syndicate manager at Commerzbank in Frankfurt.

"Investors aren't seeking exposure to the safest possible names, because they're simply comfortable with more risk so that they can secure a higher yield."

European strategists too, are steering investors away from names rated single A and higher, feeling that the yields on offer are too low - and likely to keep falling.

"We recommend keeping minimum exposure to low-beta names, and loading up in high-beta and high-yield as much as feasibly possible," said Societe Generale strategists Suki Mann and Juan Valencia.

With the iTraxx Main index now at 70bp - close to a more than three-year low, and 40% tighter than this time last year - they say current corporate yields are "unnervingly low".

SECONDARY WEAKNESS

The somewhat lacklustre performance of recent bonds in the secondary market has underscored these difficulties facing higher-rated borrowers.

Some of the deals for German automakers and chemicals group BASF traded as much as 5bp wider over mid-swaps on the break.

"BMW's bonds, for example, had a decent enough new-issue premium but a very low underlying yield," said Jens Vanbrabant, lead portfolio manager at ECM Asset Management. "As a result the bonds widened."

Meanwhile investors are being lured by the plentiful supply of alternative paper on offer further down the ratings spectrum from subordinated, hybrid bonds as well as in the senior sector.

Names like Valeo, APRR and ASF all managed to generate vigorous demand over the past fortnight, with new issues trading as much as 5-6bp tighter in the secondary.

On Tuesday, Enel spin-off Snam printed EUR600m of 10-year bonds at mid-swaps plus 128bp that subsequently tightened by as much as 6bp despite offering just a 4bp premium. Order books topped EUR1.7bn.

On Thursday, Telecom Italia printed its first bond as a junk-rated corporate - a EUR1bn seven-year offering that attracted a massive book of more than EUR7bn, while French investment company Wendel, rated BB+ by S&P, on Tuesday attracted a 7.5-times subscribed book on its EUR400m seven-year trade.

Leads said this chunky order book was down, at least in part, to a substantial bid from traditional high-grade buyers.

HYBRID APPEAL

Many investors have said that the subordinated format has presented a perfect opportunity to gain access to some very attractive names while also ensuring spread.

One London-based asset manager said he had bought EDF's triple-currency hybrids, for example, because French state ownership means the risk of default or coupon deferral looks very low.

"At the same time, the hybrid is just so much more attractive than senior because yields have come in too much."

In 2013, hybrids returned over 6% compared with the relatively paltry 2.5% from senior investment corporate credit - and some credit strategists are forecasting that those returns could be even lower if yields continue their journey south.

The average maturity for euro investment-grade senior corporate paper in 2013 was just over seven years. So far this year is at 7.4 years. And, as yields dwindle, many in the market say this is simply not enough.

"Slapping a 10bp premium on is immediately going to make a bond look more attractive," one origination official said.

"But to ensure no unnecessary money is left on the table, corporates should be looking at maturities above the seven or eight year mark," one origination official said. (Reporting By Josie Cox)

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