The financial marketplace has tended to work more efficiently when companies are easily able to borrow money from both banks and from the capital markets. Bank lending has been subdued as a result of the credit crisis and subsequent recession, but since January, corporate lending markets have boomed, leading some to say that corporate bonds are, for now, serving as a substitute for the stock market.
Through April 9, more than $974 billion in corporate bonds had been issued world-wide in 2009, according to Dealogic. That outpaces the torrid pace of issuance in 2007, when $723.6 billion had been issued en route to a record $2.127 trillion in world-wide corporate bond sales. The reason is simple, according to investors: Corporate bonds are the most desired asset class right now, at least when fund managers aren’t putting money into cash.
“If you’re looking at corporates, and wondering why there’s such an appetite, it’s because going forward, they look like the new equity,” says Matthew Smith, president and CEO of Smith Affiliated Capital, which manages $2.2 billion in assets. “There is no dividend anymore, so where is the equity surrogate to replace that? It’s high quality corporates.”
The opening of the credit markets has not been easy or quick. After a year-and-a-half of deterioration in those markets, culminating in the September 2008 freeze-up as Lehman Brothers Holdings went bankrupt, spreads ballooned and issuance was nonexistent, with just $345.8 billion issued in the third quarter of 2008, the slowest pace since the fourth quarter of 2005. The yield on the average double-A corporate bond is 3.57 percentage points greater than comparable Treasurys, an improvement from the widest level in the last year, which was 4.91 percentage points. That’s far from the 1.93-percentage-point difference that represented the narrowest spread between the two, however, and it will take more time for spreads to narrow.
“I think there’s going to be a glacial repair” in these levels, says Jessica Hoversen, fixed income and forex analyst at MF Global. She believes, however, that the narrowing will come as investors continue to shift to corporate debt and away from Treasurys as world-wide government supply continues to rise.
For the moment investors remain more comfortable with higher-quality bonds. According to Dealogic, $29.4 billion in high-yield bonds have been issued globally in 2009, which is about the same pace as in 2008, when just $28.8 billion had been issued. It’s a dramatic slowing from 2007, when $93.4 billion had already been sold world-wide. That is, in part, because investors remain concerned about corporate balance sheets, and also because of the decline in fixed-income trading, which makes these markets more illiquid.
“It’s a day-to-day environment, and it’s not as liquid,” Mr. Smith says. “There may be a buyer for your Pepsi bonds today, but you don’t know if they’re going to be there tomorrow.”