FIIG thought it useful to track some key indices comparing the impacts on equity prices and credit spreads for both the GFC and this latest COVID-19 crisis.
By way of explanation, the graph below has three lines:
- ASX 200 (self-explanatory).
- The Aussie iTraxx is used as a proxy for Australian corporate bonds spreads and is measured in basis points (bps). The Australian itraxx is made up of 5y credit default swaps for the 25 most highly traded investment grade Australian companies. The itraxx index is a tradable instrument in its own right, with pre-determined fixed rates and the prices set by market demand. A credit default swap is a form of insurance designed, when purchased by an investor, to immunise against credit margins increasing. As credit spreads increase, the cost of purchasing the itraxx also increases.
- Bloomberg Barclays US OAS is a measurement of credit spreads relative to the risk free rate for the universe of investment grade fixed income securities issued in the US.
What does it all mean? What do we draw from the lines?
- When the ASX goes down, corporate credit spreads go up. This is entirely logical as the lower the share price of a corporate, the less the equity protection available to corporate fixed income investors.
- Both itraxx and the Bloomberg Barclays US OAS are imperfect proxies for credit spread movements for individual fixed income securities. That said, the indices are important pricing benchmarks to aid individual fixed income security pricing. We can deduce from the graph that since 20 Feb 2020, credit spreads for the universe of corporates making up these indices have increased by ~300bps or 3%. If an Issuer, prior to 20 Feb, priced a sub investment corporate issue at a credit spread of say +500bps, that spread should now be +800bps. This is merely theoretical as current market demand is dislocated.
- Identical phenomena were present through the GFC but the speed of credit spreads increasing was significantly slower as the full impact of the GFC, and steps to remediate it, unfolded. The spike in credit spreads resultant from COVID-19 has been incredibly rapid. Further, post GFC, credit spread normality resumed within months.
- The second graph below is a microcosm of the indices referred to above as they pertain to credit spreads on individual Australian high yield securities. Given the limited data set, these indications of credit spread movements are less reliable.
Whilst times are difficult in terms of market dislocation, there has been meaningful activity in both the US and Australian primary markets:
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- Investment Grade (IG) issuance: Whilst the investment-grade market was shut for much of February and within in early March, some of the most credit-worthy companies like Exxon Mobil Corp, Oracle, Nike, Home Depot, PepsiCo issued in what’s been a record flood of issuance in March. These companies are rightly regarded as more immune to the impact of COVID-19 but motivated to secure funding prior to COVD-19’s full impact. Uniquely, investors rotating out of equities into bonds has been a partial driver of the issuance.
- High yield issuance: stability in primary markets even in the BBB rating area has meant lesser rated credits have been able to access primary markets. Yum! Brands (worldwide owner of KFC, Pizza Hut, Taco Bell etc.) (Moody’s B1) issued five year bonds at 7.75% which was better than price guidance, noting this deal quickly traded at a sizable premium in secondary markets.
- To the 4th week of March there have been some primary issuance most notable RMBS with those structures predominantly IG. This is expected to continue, albeit at a significantly lower pace than prior to COVID-19 particularly as Issuers need to replenish warehouse lines. There have been some IG corporate issuance.
In the US and Australia, Issuers and investors are showing early signs of accepting the new normal of credit margins with further expectation that post market dislocation, credit spreads may tighten further. Pressure will build on Issuers to refinance bank and bond outstandings. US and Australian Federal Government stimulus is currently a huge factor encouraging investors to take on more risk. That and medical breakthroughs, infection curves being flattened (in Australia), faster testing and the end point of a vaccine may see a market dislocation being shorter than otherwise expected. Bank deposit investor returns are virtually nil. These factors combined will result in a revitalisation of corporate bond issuance in both the US and Australia. Issuers should be motivated to think that opportunities for bond finance may not be too far away. FIIG will assist Issuers to both monitor the market and get in a position of readiness when market conditions present themselves.