In last week’s Weekly Credit Insight, we examined the unequal recovery in the high-yield market owing to higher levels of defaults. In essence, asset allocators are balancing their desire for additional yield with an unwillingness to assume further credit risk during this period of sluggish economic momentum. Indeed, this was evident from the performance of high-yield bonds, which varied depending on an issuer’s credit quality. We can see further evidence of this in the corporate hybrid market.
Corporate hybrids are mainly issued by large companies with an investment grade rating at the senior level. As such, these companies are better placed in the current uncertain circumstances: they have more options available to manage any cash flow hits (such as reducing returns to equity holders or selling assets), and central banks and governments recognise the importance of supporting large companies during these unprecedented times.
In this environment, asset allocators have not moved further down the credit rating spectrum. Instead, they have chosen to move down the capital structure, searching for stronger, higher-rated corporates. In addition, the anchoring of spreads in investment grade corporates, coupled with lower government bond volatility owing to support from central banks, is encouraging investors to consider corporate hybrids. Consequently, this segment of the market has performed well, with average spreads and yields 58 basis points (bps) and 45bps wide of February tights, respectively (see figure 1). What’s more, this is particularly true for US dollar-denominated debt given the convergence between yields in the US and the rest of the world. Against this backdrop, issuers have recognised that a refinancing opportunity exists. Indeed, we’ve witnessed a flurry of new hybrid deals in recent weeks – which no doubt serves as a good warm-up for the high-yield primary pipeline in the coming month.
Figure 1. Global corporate hybrids echo the current ‘reach for yield’ environment
Source: Federated Hermes, ICE Bond Indices, as at 02 September 2020.