The bonds of big-name global companies are getting more respect lately than most governments’ debt is. In fact, bonds from well-known firms have appreciated in price so much that their spreads over even best-of-breed government debt _ U.S. treasuries and German bunds _ are negligible. The migration to top-name corporate debt is not just for yield; now, it’s for security.
The prolonged crisis in Europe has inverted the assumption that governments’ power to tax and print money puts public debt in the top tier of the bond market. Investors now are watching many governments’ revenue shrivel in the European recession and the global slowdown. Even former growth stories such as Brazil are seen as weak with respect to security of tax revenue.
It’s a different story for corporate debt from globally recognized names. In August, three-year, U.S.-dollar bonds from Unilever PLC, which Standard & Poor’s Financial Services LLC (S&P) rates at A-1, sold at 0.45% a year to maturity. These bonds recently have traded to yield 0.42%, vs 0.31% on three-year U.S. treasuries.
Furthermore, IBM Corp. recently sold 10-year, U.S.-dollar bonds, which S&P rates as AA-, at 1.875% a year to maturity. Ten-year U.S. treasuries have been priced to yield 1.6% on the same basis.
In Canada, the federal/provincial spread on five-to 10-year bonds usually is 40 to 50 basis points (bps). Canadian corporate/government spreads are more traditional, at 100 to 150 bps, but our bonds have not been priced into the stratosphere to the same degree as U.S. treasuries and German bunds. And most Canadian companies aren’t on the same scale as IBM and Unilever.
“Global investors are accepting lower credit risk premiums for many large, stable and well-diversified corporations than many sovereign credits,” says Anil Passi, managing director with Toronto-based credit-rating agency DBRS Ltd. In other words, big global firms are now seen as safer investments than government bonds.
“The problem is that there is a shortage of quality product,” says Chris Kresic, partner and co-lead for fixed-income with Jarislowsky Fraser Ltd. in Toronto. “That demand for top-quality bonds extends to secure corporations.” Companies have advantages over governments.
Companies may have large amounts of cash on their balance sheets and positive free cash flow bringing in more of it. Moreover, a business always has its assets exposed to seizure by bondholders if interest or principal is not paid on time.
In contrast, some governments may default or force investors to accept huge interest haircuts and defer payments for decades _ as Argentina did a decade ago and Greece has done recently.
In this new bond market, large, non-financial corporations are borrowing money at remarkably low rates. In August, corporate bond issuance around the world rose to US$120 billion, the highest level since record-keeping began in 1995 and more than double the US$58-billion monthly average, according to Bloomberg LP.
The market has snapped up these issues for their perceived combination of security and expected yield to maturity.
Responsibility for the inversion goes to central banks, say bond market analysts. “Central banks have bought weak loans from the commercial banks and given them more money to invest,” notes Rémi Roger, vice president and head of fixed-income with Seamark Asset Management Ltd. in Halifax. “Commercial banks turn around and buy government bonds, which strengthen their balance sheets. This heavy buying of sovereign bonds has pushed up their prices.”
In a sense, the question is: who can be trusted? Shaky government finances backed by central banks’ asset-juggling and bank balance sheets held up on government crutches are not fooling investors, Roger says. The sovereign/corporate debt inversion is not entirely new, says Jack Ablin, executive vice president and chief investment officer with BMO Harris Private Bank in Chicago: “It happened in the Great Depression, when investors believed that companies with stable revenue streams were more reliable than countries with uncertain tax revenue. Highquality corporate yields dropped lower than U.S. treasury yields.”
What happened in the 1930s is happening again, Ablin says: “Big companies’ unprecedentedly low costs of borrowing could continue and be exacerbated by central bank action. The flight to highquality debt of companies with reliable earnings streams implies falling yields on top corporate debt relative to government bonds. This spread may widen in long-term bonds of top companies.”
The trend toward shopping for security in big-name corporates is likely to continue, Kresic says: “The Basel III accords have cut bank leverage and thus reduced the amount of money banks can lend. Companies are forced to go to the bond market for money.
And best-of-breed corporates cater to the continuous bid the market provides for an alternative to government debt.
From a credit-quality perspective, corporate spreads will continue to narrow, Kresic explains: “As long as investors are more comfortable with corporate debt than with government debt, then, apart from U.S. treasury issues and German bunds, fear of government default risk will tend to push up prices of top-name corporate bonds.”
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