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Have credit margins peaked?

Investors, analysts and financial commentators are all somewhat gun-shy from believing the statement that the “worst is now behind us” with the global credit crunch and banking crisis. There have been two false starts to this milestone already this year, with the Bear Sterns and Fannie Mae/Freddie Mac fiascos and subsequent US Federal Reserve rescue acts.

However in recent weeks sentiment and confidence in the credit markets is showing early signs of improvement. From the perspective of an NZ corporate borrower monitoring debt market credit spreads, the worst of the increases may be over and in some cases spreads are easing back down. However any expectations of issuance spreads returning to pre-credit crunch levels should be dismissed. Two corporate benchmarks we monitor are the credit default swaps spread pricing on a 5-year term for Telstra and Telecom NZ (both single “A” credit rated). Pre-credit crunch historical spreads for both averaged 30 basis points.

From July 2007 until March 2008 the spreads sky-rocketed to 160 basis points. By May 2008 they recovered back to 50 points, and now trade around the 80 basis point area. Our estimate is that these credit spreads will settle at 60 to 80 basis points, more than double the pre-crunch levels.

Telecom NZ have re-launched their retail “Telebonds” programme with tranches of 3, 5 and 7 ($300m) years at pricing of 75, 115 and 140 basis points over swap respectively. Telecom has also issued in the Swiss Franc corporate bond market. The majority of the other local debt market new issues in recent months have been financials, namely:-

  • South Canterbury Finance (BBB-) – $125m, 3 year bond at swap +275 bps.
  • MARAC Finance (BBB-) – $100m, 5 year bond at +325 bps.
  • BNZ (AA) - $50m, 2 year RTD at +70 bps (current)
  • ASB Bank (AA) - $180m, 5 year senior bond at +110 bps and $325m, 3 year bond at +90 bps.
  • Westpac (AA) - $200m, 3 years at +90 bps.
  • ANZ Bank (AA) - $50m 3 year senior bond at +90, $100m 2 year at +68 and $175m 6 year at +117.
  • ANZ Bank – Subordinated bond (A+) $895m, 5 + 5 years at swap +200 bps.
  • Rabobank (AAA) - $100m, 3 year senior bond at +22 bps, reflecting their superior credit rating.
  • Auckland City Council (AA) - $50m 5 years at +94 bps, $25m 7 years at +104 bps and just this last week $30m 2 years at +30 bps. However there was limited institutional investor support at that lower pricing.

Some of the banks have been warning corporate and business banking borrowers that the OCR may go down, but their borrowing costs will not as the banks have to pass-on their own higher cost of funds. Sure, borrowing margins from banks have gone up, but not all the lending banks have been forced to pay “over the odds” to get term money from offshore markets. As the pricing from banks increases, a number of the larger corporate borrowers will now be re-examining the demand from retail and wholesale investors for corporate bonds to diversify their funding sources.

DISCLAIMER: The information contained in this document is given in good faith and has been derived from sources believed to be reliable and accurate. However, neither Asia-Pacific Risk Management Limited nor any of its employees, gives any warranty of reliability of accuracy nor accepts any responsibility arising in any other way (including by reason of negligence) for errors or omissions herein.