Credit markets, unlike the global economy, are already out of their virus lockdown. BP’s $12 billion issuance of bonds that count as equity shows that investors’ hunger for esoteric securities is alive and well. There’s little choice when central banks are flooding markets with liquidity.
BP’s first sale of hybrid debt looks neatly timed. The securities are like bonds, in that they pay interest, but rank below ordinary debt, and allow coupons to be deferred. That means rating agencies can treat them as partial equity in their models, and they can lower reported gearing levels. On Monday Chief Executive Bernard Looney said he would write down up to $17.5 billion of assets to factor in lower fuel prices. Now, thanks to bond market alchemy, he has replaced a big chunk of that lost equity at an annual cost of around 4.5%.
Corporate hybrids are often fair-weather investments: when markets fall, they tend to suffer and issuance dries up, as investors worry more about losing coupons or the bonds not being redeemed when expected. But now they are in fashion, as western central banks are hoovering up government and investment grade debt and suppressing rates, leaving money managers little choice but to delve into riskier areas. Central banks will buy more bonds this year than governments and companies will issue in advanced economies, leaving private investors with a dearth of fresh assets to buy, Citi analysts reckon.
Acquiring BP-style funky debt is arguably logical right now. In crises companies often deleverage, meaning lenders who invest in their debt should worry less about aggressive dealmaking. And, if the alternative is losing money in cash deposits or negative-yielding government bonds, then corporate debt becomes more appealing. While the demand for yield has already erased much of the panic caused by the lockdown, the spread on the iTraxx Crossover index of credit default swaps linked to speculative grade corporate debt is now around 370 basis points, some 70 basis points above its five-year average, according to Refinitiv data. In other words, investors are still getting some reward for taking risk.
Still, the same index reached roughly 700 basis points amid the panic of March. If a second wave of the virus takes hold, and governments impose more lockdowns, the reversal could be brutal and swift.
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