November 10, 2017 / 12:37 PM / in a year

Unbridled rally leaves corporate market in a muddle

* Post-ECB rally takes spreads to historical tights

* Secondary valuations create headache for execution

By Helene Durand

LONDON, Nov 10 (IFR) - A rampant rally in the European corporate bond market has distorted some borrowers’ curves to such an extent that pricing new issues could become a minefield - a scenario reminiscent of what happened to the covered market in 2014.

Pricing a new issue is usually straightforward, with a company’s outstanding bonds used as reference points to gauge fair value and a spread is then added to lure investors.

However, corporate spreads have snapped tighter after the ECB late October announced an extension to its asset purchases until at least September 2018 to the tune of €30bn a month.

“We’ve moved too fast, too quickly on no supply. Some curves are not curves anymore, they’re lines,” said a senior syndicate banker.

“The ECB broke the covered market a couple of years ago when issuers kept pushing and it feels reminiscent of that. You need two valid data points for a pricing output and the problem is, one part of the mathematical equation is now screwed and you can’t price deals off secondaries.”

The impact of the ECB has been huge. BMW’s euro benchmarks, for instance, are bid inside swaps out to 2024. AB InBev’s curve trades in the very low single digits up to the five-year point.

This has made assessing fair value much more difficult, especially for credits that have been squeezed by the central bank purchases, which began in June 2016 and now total over €122bn for corporate paper.

Daimler’s A2/A/A- rated €1bn 10-year and a €600m deal for Baa1/BBB/BBB rated Whirlpool at the same tenor raised eyebrows this week after the issuers paid respective concessions of 15bp and 8bp versus their curves.

This was in contrast to recent supply where borrowers had been able to call the shots and come with little or no premium.

“When all your secondaries are below 10bp, they’re not as relevant as before,” a DCM banker said. “Bonds are so tight, we shouldn’t be focusing on new issue premiums; it should be more about where deals come versus other recent new issues. Secondaries can be a bit of a red herring.”

Daimler’s curve is bid inside 5bp over swaps out to seven-years with a pocket in 2022 and 2023 quoted at negative spreads.


While the sector seemed to have taken the impact of ECB purchases in its stride, the spectre of what happened to the covered market now looms large.

The ECB’s aggressive covered purchases had severely distorted valuations by the end of 2014 and early 2015, forcing real money investors out and leaving order books languishing.

Daimler found enough interest to cover its €1bn deal but the €1.6bn book was smaller than seen on other recent issuance.

Many bankers and investors are asking how long the rally can continue before the market readjusts away from the eye-watering valuations.

The Z-spread on the iBoxx corporate index broke through its 2007 tights of 32bp in early November on a composition-adjusted basis, according to Citigroup analysts.

“Negative net supply in recent weeks and a benign global backdrop have contributed to the remarkably strong tone,” they wrote.

“But, as the recent outperformance of euro vs US dollar credit post-ECB suggests, Draghi’s dovishness has clearly been the chief culprit. With most of the visible catalysts into year-end having being cleared and the ECB liable to step up buying to offset low liquidity in December, we fear the near-term squeeze may have even further to go.”


Reduced appetites and bigger premiums can partly be blamed on technicals but there are other factors at play.

In Daimler’s case, bankers said the sheer scale and frequency of its issuance had affected demand.

“Daimler is in the market a bit more often than a credit like BASF,” the DCM banker said.

For Alstria Office REIT, BBB (S&P), it was more to do with plentiful supply out of the sector. The €350m 10-year, which priced at 80bp over swaps, struggled to gain traction and only garnered some €550m of demand.

“We’ve had loads of REITs this year and a 10-year Triple B is not necessarily the sweet spot of every investor,” another senior syndicate banker said. “The risk weighting under Solvency II is not favourable either and this is a marginal name coming super tight.”

The investor response contrasted with that for Akelius’s €500m long six-year, also BBB by S&P, which priced the previous day at the same spread over swaps on books of more than €1.6bn.

“REITs have done a lot of deals and they’re doing it because it works for them,” the DCM banker said. “It’s perhaps to be expected when you’ve had so much supply as we saw with the Italian utilities. Issuers are still getting fabulous outright spreads.” (Reporting by Helene Durand, Editing by Julian Baker, Ian Edmonson)

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