Corporate bond gravy train slows after five-year express ride
Unease over the hefty prices for corporate debt - which fund managers say do not reflect vulnerability to market shocks - has meant many new bond issues have struggled to find buyers, when until recently they would have flown off the shelves.
Aside from expensive valuations and miniscule yield spreads over "safe" government debt, concerns centre around high levels of leverage. And in Europe, the European Central Bank looks set to end soon the stimulus programme under which it has bought 143 billion euros (£125 billion) in corporate bonds since early 2016.
"There's a big vulnerability in the corporate bond market at the moment," said Mike Riddell, a fund manager at Allianz Global Investors, which manages 498 billion euros worth of assets.
"In Europe, the ECB has been helping the market out, and in the U.S. and in China, leverage is quite high. If you strip out the tech companies like Google, Apple and Amazon that are sitting on massive cash piles, the numbers are far worse."
ECB buying has driven euro corporate bond yield spreads to their tightest since the global financial crisis, with spreads over benchmark asset swaps dropping from 116 basis points at the start of 2016 to as low as 38 basis points in February, though it has widened since.
Corporate bond spreads show signs of stress - https://reut.rs/2IWVLAV
At the peak of ECB bond buying and optimism over the sector in 2016, the average yield of the Iboxx non-financials index <.IBBEU00EE> fell as low was 0.69 percent. Of late however, the yield has risen to 1.18 percent.
Riddell said Allianz's strongest conviction view is for a bear market in corporate bonds. To express that, it is investing in credit default swap (CDS) indices such as the iTraxx Europe Subordinated Financial Index and the CDX U.S. High-Yield Index.
A CDS is a derivative that effectively acts as insurance against losses on bonds. They are therefore bought by investors when they are pessimistic on the underlying asset.
"We are also heavily underweight cash corporate bonds. Our benchmark is about a third global corporate bonds, and we have slightly less than zero exposure overall," Riddell added, referring to the Bloomberg Barclays Global Aggregate index.
ROOTED IN STIMULUS
The corporate bond boom is rooted in the stimulus unleashed by global central banks in the post-2008 years and after the 2011-2012 euro crises.
As companies rushed to bond markets for cheap cash, the ratios of credit to gross domestic product skyrocketed, hitting a record high 210.5 percent in China and a seven-year high of 152 percent in the United States, according to the Bank for International Settlements.
The euro zone trend is now downwards but remains at a historically high 160 percent.
Credit-to-GDP global - https://reut.rs/2GiYQd4
Euro zone bond sales shot to 383.5 billion euros last year - a 45 percent jump from 2013 levels, according to Thomson Reuters data.
BNP Paribas Asset Management, with 569 billion euros under management, is short European credit, fearing contagion from across the Atlantic.
"U.S. corporates have increased their leverage, but a lot of them have done it to conduct share buybacks, so this market could come under pressure," said Patrick Barbe, head of European fixed income at BNP Paribas Asset Management.
"Credit market pressure is more on the U.S. side, but it will eventually affect Europe as well," he added.
International Monetary Fund data last year showed that the net leverage - measured through the ratio of net debt to EBITDA - of S&P 500 companies was at its highest level at the end of 2016 since before the financial crisis.
Amundi, one of the world's largest investors with assets under management of over 1.4 trillion euros, hasn't gone short but has scaled back corporate debt exposure.
"We were very long credit on the last five or six years. We remain with longs in some parts of the market, but it is significantly less than what we had in the past," said Gregoire Pesques, head of the global credit investment team at Amundi.
SIGNS OF STRESS
For the first time in years, borrowers are finding resistance in the roughly 300-plus-billion-euro-a-year market for European syndicated corporate bond sales, the main means by which companies borrow money in the fixed income market.
For instance, British information services firm Relx announced a 600 million-euro debt sale on March 15 but had to revise that down to 500 million euros.
In a market where it has been the norm for borrowers to see twice or three times as much demand as they are raising, this came as something of a shock.
Some bankers told Reuters that a couple of German investors recently declined to engage with new sales, citing the need for greater clarity on the outlook for credit.
"Markets have been great for such a long time," said a banker who manages bond sales for European companies. "Issuers need to brace themselves for more elevated spreads (over benchmark borrowing rates) going forward and for investors to be even more picky. It's going to be a new way of thinking."
(Reporting by Abhinav Ramnarayan and Pauline Renaud of IFR, editing by Sujata Rao and Larry King)
By Abhinav Ramnarayan and Pauline Renaud