Sovereign Default Risks Brewing Once Again
European corporate bond spreads widened 10 basis points last week, with an even greater weakening in the financial sector.
Going into last week, credit spreads for many industrial issuers were at their tightest level for the year. As the week wore on, we experienced a bit of a backup as industrial spreads slowly widened. However, the financial sector picked up the slack and tightened enough to result in a 3-basis-point tightening in the Morningstar Corporate Bond Index to +149. All in all, it was an orderly market. The new issue market continues to be robust, and we did not see any significant credit-specific events in the domestic credit markets.
The European credit markets did not fare as well. Sovereign default fears, which had been brewing under the surface, rose to the forefront by the middle of last week. As a result, European corporate bond spreads widened 10 basis points, with an even greater weakening in the financial sector.
Over the past month, Ireland's 10-year bonds have widened more than 200 basis points on a nearly 20-point drop, bottoming out below 75. These bonds ended the week at 77 with a resulting yield of 8.07%, a +580 spread to Bunds. This dragged the other periphery European sovereign credits wider as well.
Five-year credit default swaps widened across the board, with several past their previous highs. Portugal widened 40 basis point to +480 (a new high), Spain widened to +280 (back to its prior high), and Greece widened 30 basis points to +880 (a 200-basis-point widening over the past month). This spread widening is evidence of the credit markets warning of increased default risk.
Even though Ireland reportedly has enough cash to last through the second quarter of 2011, we expect that the rapid decline in Ireland's bond price will prompt the European Central Bank and International Monetary Fund to provide a backstop financing plan in the near term. In fact, as rumors of an emergency financing package began to swirl about at the end of last week.
New Issue Market
The new issue market continued to slake the voracious demand for corporate bonds. We expect issuers to crowd the market next in order to price deals ahead of the Thanksgiving holiday. The market should then dwindle until the last week of November. We suspect a significant number of issuers are eyeing the market, ready to pull the trigger before the year is over in order to lock in low interest rates and tight credit spreads.
Time Warner Cable (ticker: TWC, rating: BBB-) is an example of a firm lured by current low interest rates. The firm recently announced plans to buy back as much as $4 billion of its shares. With the firm sitting on more than $1.1 billion in cash and generating around $2 billion in cash flow annually, it could easily have simply used internally generated funds to complete the buyback over 18 months or so. Instead, the firm raised $1.9 billion via the issuance of notes that mature in 2021 and 2040 at spreads on the low side relative to our BBB- rating. The move puts additional long-term financing in place and will allow the firm to bring debt up to 3.25 times EBITDA--a target management put in place a couple of years ago--in short order.
David Sekera does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.