Naisbitt King Bond Market Commentary 9th July 2021
Positive news as the City of London looks set to go it alone after EU talks fail
New euro issues push past €1trn this year
With ever reducing yields is the high yield bond market still favourable?
Good news for banks after passing the Fed’s stress tests
Sustainability-linked bonds are a growing asset class
Qatar Petroleum sold the largest emerging-market bond sale this year
Salesforce.Com bids for Slack Technologies – issues jumbo bond deal
Last week the UK Chancellor, Rishi Sunak, admitted that country’s talks with the EU to grant access to each other’s markets for financial services ‘has not happened’. ‘Now, we are moving forward, continuing to cooperate on questions of global finance, but each as a sovereign jurisdiction with our own priorities,’ the Chancellor said. ‘We now have the freedom to do things differently and better, and we intend to use it fully, but I can equally reassure you, the EU will never have cause to deny the U.K. access because of poor regulatory standards.’ Rishi Sunak also said it’s ‘a plan to make this county the world’s most advanced and exciting financial services hub for decades to come, creating prosperity at home and projecting our vales abroad.’ We believe that this will be positive for the City of London, Naisbitt King Asset Management and importantly, our clients.
New bond sales in Europe are about to break past €1trn this year as issuers launched debt at rapid speed for the second year running. About half of this year’s total has come from sovereigns and supranational’s such as the European Union, which are now raising funds at record-low borrowing costs to fund fiscal programs, aiding economic recovery. The continued backing by central banks, including the European Central Bank, has driven the cost of insuring against default of investment-grade debt to the lowest since December. Borrowers are of course taking advantage of cheap funding while they can with companies using the money raised to pay for upcoming maturities, lengthen duration and to build war chests for future corporate plans. Yesterday the European Central Bank raised its goal for inflation and may let it overshoot the target for a while, giving officials more discretion in how to bolster the economy after years of lacklustre performance.
Bank stress tests
Towards the end of June, the Federal Reserve released their yearly bank stress tests. All the 23 institutions tested passed with flying colours with the Fed saying they had remained ‘well above’ minimum required capital levels during a hypothetical economic downturn. Importantly, the banking industry will regain a level of autonomy it lost during the crisis. The idea is that if an institution stays above a particular stress capital buffer requirement and all their other requirements every quarter, a bank can technically do whatever it likes with regards to dividends and buybacks. This is very good news for the area of the financial bond market that we have been keen on this year and before, namely the junior subordinated, CoCo’s ATI levels of security of significantly important international banks. We have said that bonds in these categories give excellent risk / rewards with good yields compared to bonds in other sectors with the same ratings.
The stress test results were particularly good for Deutsche Bank AG (DB) after it had repeatedly failed assessments in the past. As I said in our Bond Commentary of 4th June, we have finally bought a bond in DB after a break of many years which avoided holding the bank’s underperforming debt. At senior level DB is now rated A3/BBB+/BBB+ all positive. Since purchase DB has been taken off negative watch. The DB 4.789% perpetual bond has tightened by over 20bps.
Treasury yield curve flatter
The yield on the U.S. Treasury 10-year has now dropped to 1.33%, the lowest since
February. And as can be seen from the chart below the Treasury 30-year now yields less than 2% and the 5-year is below 0.77%, the lowest since early March. Further, the difference between the two maturities has ‘flattened’ to 115bps, the smallest yield gap since last September, from 140bps before the recent Fed statement. The move is being exaggerated by investors unwinding crowded trades betting on curve steepening. It’s possible long-end steepeners were being used as a positive carry way of positioning for higher yields, especially with the expected Fed lift-off date nearly two years away, and the unwinds of those positions added flattening pressure,’. The yield curve between two-year and 10-year notes flattened to 112bps today from 137bps just a month ago, also the flattest since February.
Graph showing the yield differential between the U.S. Treasury 5 and 30-year bonds
High yield bonds
Are so called high yield bonds, sub-investment grade, worthy of their name and are they better investments now than in the past when they regularly had coupons with double digits? At the turn of this century the sub-investment grade market was relatively small. Today the market is said to be some $2.6trn in size with 59% of the bonds rated BB. As I have said in previous Bond Commentaries, default rates continue to remain low, meaning the high yield market has continued to be a stable environment for investors. With larger issue sizes liquidity has also continued to be positive for investors. In fact last year, at the height of the pandemic tension, liquidity for investors actually increased. U.S. high yield bonds rallied to drive the index down to a new record low yield of 3.72% and risk premium as reflected in the spreads to +265bps, the lowest since June 2007.
Although we are no longer seeing the big coupons and high yields, we are seeing an established, liquid, stronger market with sounder foundations than 20 years ago. The global high yield market comprises a vast range of issuing companies, from household giants such as Fiat Chrysler and Netflix, to small and medium-sized companies that are raising funding via the bond markets for the first time. This creates a diverse mix of issuers that can reward strong credit analysis. We are confident that a well-diversified, stable high yield bond market used as part of a broader portfolio will prove supportive to our clients’ portfolios going forward to the second half of the year.
SoftBank, the Japanese technology investor, falls into the high yield bond category. Last week the company raised a total of $7.35bn in a dual-currency deal. It sold $3.85bn and €2.95bn making it the second largest offshore deal this year. SoftBank posted the biggest-ever quarterly profit by a Japanese company earlier this year, driven by gains at its investment arm. The company, founded and led by Masayoshi Son, came to market at an ideal time with yields on junk-rated dollar debt in the U.S. at a record low and tech stocks near a record high. Still, the prospect of higher interest rates ahead poses a potential headwind for one of Japan’s most heavily indebted companies. SoftBank got the equivalent of $16bn from investors for the $7.35bn deal. These SoftBank bonds are rated a sub-investment grade Ba3/BB+ all stable.
Enbridge Inc, the Calgary based energy company, brought the most interesting transaction for a while, pricing a 2-part $1.5bn deal with a 12-year sustainability-linked bond (SLB)* and a vanilla 30-year tranche. Both bonds are rated at the same level at Baa1/BBB+/BBB+ all stable.
The $1bn 12-year SLB’s coupon will step up 50bps if Enbridge fails to reduce Scope 1 and Scope 2 Emissions intensity by 35% by the end of 2030. That is double the standard 25bps we have seen on other SLB deals. The bond, which carries a coupon of 2.5%, is trading slightly tighter since launch. The 30-year senior unsecured vanilla tranche has a coupon of 3.4%. Although at $500m, a third of the size of the 12-year SLB, this longer tranche received almost as many orders at $2.6bn.
Yesterday Chinese Smartphone giant Xiaomi Corp. raised $1.2bn with a 2-part dollar deal. As with Enbridge Inc. the week before, one of the tranches was a $400m 30-year green sustainability bond which itself received $2.65bn of orders. Xiaomi said the proceeds will go toward funding eligible projects under its “Green Finance Framework,” an environmental scheme. Xiaomi, the world’s third-largest smartphone maker, has continued to expand globally and is looking at breaking into new areas like electric vehicles. In March, Xiaomi said it would launch its own electric car business and invest $10bn over the next 10 years. Xiaomi its rated Baa2/BBB-/BBB.
* Sustainability-linked bonds are a growing asset class that generally penalises issuers with higher borrowing costs if they do not meet certain environmental, social and governance actions. If the issuer meets or exceeds the targets, the coupon remains unchanged. In contrast to green bonds, companies can use the deal proceeds as part of their general funding plan. While these structures are more popular in the European and emerging markets spaces, American utility NRG Energy brought a 7-year bond late last year that carried that 25bps step-up provision. To avoid the step-up, NRG must reduce greenhouse gas emissions to a certain level by the end of 2025.
NatWest Group (NWG) has certainly returned to investors good books. A couple of weeks ago the bank launched a CoCo AT1 perpetual with a 10 year call. The maximum size of the issue was limited to $750m but the original idea of a 5.125% yield was soon reduced to 4.6% during the launch process after an orderbook of nearly 10 times the issue size was obtained. At senior level NWG still has a very mixed bag of rating opinions at Baa2/BBB/A, positive/stable/negative, with this new subordinated bond assigned Ba2/B+/BBB-. One day after the issue was launched S&P moved its rating on the bank from negative to stable. NWG shares have gained 25% this year to a level last seen in February last year. Although the bond’s price is higher since launch, this bond has underperformed with the current spread 8bps wider.
The state energy company of Qatar Petroleum sold the largest emerging-market bond sale this year, selling $12.5bn of dollar bonds as it seeks to raise output of liquefied natural gas and cement its dominate position in the market. Qatar sold a four-part deal with tranches maturing in 5, 10, 20 and 30 years, with the longest part yielding 3.3%. The company’s last dollar sale was in 2006, when it raised just $650m. Investors backed the massive deal with an even more massive orderbook of $41bn. Qatar Petroleum is well rated at Aa3/AA-/AA- all stable. Since launch the bonds have all tightened, which bring the yield on the 10-year tranche down to 2.27% - 5bps tighter.
Salesforce.Com, Inc had the U.S. high-grade primary market to itself when it marketed a jumbo sale in what was be the last major deal ahead of the July 4 holiday in the U.S. The San Francisco-based company has most of the proceeds earmarked to support its $27.7bn purchase of Slack Technologies, the American software company. The 6-part $8bn deal, with maturities ranging from 2024 to 2061, was four times covered. Funds from the $1bn seven-year tranche will go toward financing new or existing green or social projects. These Salesforce senior bonds are rated A2/A+ both stable. All tranches are trading tighter.