Weekly Credit Update

CDS indices are slightly up compared with year-end.
Primary market activity was high during the first few days of the year.
New issue premiums were elevated in the region of 10-30bp.
We expect good investment opportunities to continue in H1 12.

Market comment

CDS indices are up slightly (2-5bp) compared with year-end, although they were temporarily lower during the week. We have seen limited activity in the secondary market, especially within investment grade credits. The secondary activity we have seen has been concentrated within high-beta credits, where there has been good buying interest. Therefore, in order to take the temperature of the credit space, one is better off looking at the primary market where the activity has been much higher.

High primary market activity

Within the credit space, it is the rule rather than the exception that issuers quickly enter the primary market in order to get funding in place as soon as primary market conditions allow. This has particularly been the case throughout the recent crisis years, as no one ever knows when the primary market might close.

With high primary market activity during the first few days of 2012, this year has so far been no exception. This should come as no surprise, as the new issuance activity in H2 11 was limited and as the first 3Y ECB LTRO, which ended at almost EUR500bn, has provided the financial system as a whole with excess liquidity, highlighted by Wednesday’s small take in the ECB’s 3M USD tender. We still lack clear evidence that this liquidity will be put to work but it is our expectation that some of it will be channelled into fixed income instruments, including shorted dated corporate bonds.

So far, we have seen elevated new issue premiums in the region of 10-30bp with subsequent performance in the secondary market (0-5bp). The subsequent performance is a positive sign, especially given the latest few days’ widening in CDS indices. In our view, the resilience of new issues to spread widening indicates that bonds are well placed with investors and that investors are lined up with cash to invest in new issues. An important test is likely to come when investors use up excess cash and have to sell in the secondary market to free up cash for primary market investments.

We still recommend a cautious approach for the first part of the year. First, we see a risk that overall risk premiums could blow out again following an intensification of the European debt crisis, and this could once again lead to higher credit spreads, lower liquidity and an almost closed primary market. Moreover, the combination of private sector deleveraging and public sector austerity measures could easily end up worsening the operating environment for corporates, especially those with high geographical concentration in Europe. In our view, credit investors are likely to see several good buying opportunities in H1 12 and we, therefore, recommend keeping some powder dry in order to benefit from this. Happy hunting in the new year.