Barclays analysts: spreads dislocated in high-grade; issuance to remain robust through year-end

By Andrea Heisinger

New York, Sept. 24 - Spreads remain dislocated in the investment-grade bond market, and issuance should hold steady for the remainder of 2009, analysts from Barclays Capital said Thursday morning at a fourth-quarter outlook briefing in New York City.

At the briefing, Ashish Shah, co-head of global credit strategy, called recent moves in the investment-grade and high-yield bond markets "selectively constructive."

Investment-grade credit has turned in a 17% return year to date, he said.

"We've never seen that before," he added. "We used to only see [the median spread on an] A [rated] industrial credit at roughly 400 basis points at the beginning of the year. Now it's 115 bps. Before [the recession], the median was 80 bps."

Some of the spread dislocation from the end of 2008 has gone away.

"The risk return changed," Shah said. "Within IG, the value remains in BBB [rated] industrials. Basically we're seeing double the average spread at 220 bps." Before the financial crisis, those bonds were priced at an average of 110 bps, he said.

Spreads will likely remain relatively dislocated, he said, adding that that is not surprising, especially in the financial sector.

"We saw too much financial paper," he said. "There has been upward of $200 billion FDIC [backed] paper."

Banks and other financial names like General Electric Capital Corp. issued this debt to pay down commercial paper. However the Federal Deposit Insurance Corp. Temporary Liquidity Guarantee Program is done at the end of October, Shah noted.

Industrial issuers have issued opportunistically of late and used the proceeds to pay down commercial paper and have cash on hand, he said. This was despite the unprecedented level of spread dislocation.

"Everyone piled into corporate credit and sold Treasuries and agencies [bonds]," he said.

"When single-A spreads are at the level they're at, investors are no longer able to absorb changes in interest rates. We're afraid they're going to reallocate into other asset classes, including equities."

Investment grade favored

Shah said he sees investors sticking with investment-grade paper, especially that from quality names such as Target Corp. and Wal-Mart Stores, Inc., calling them the "strong players in IG."

Issuance should remain steady in the investment-grade market for the remainder of 2009, Shah said.

In the United States, companies are at 2003 levels in regard to commercial paper outstanding, he said, adding that "corporates are very liquid."

"We continue to see opportunistic funding, for [mergers and acquisitions] mostly," he said. "They're kind of done [issuing] in 2010."

He clarified this by saying that issuers from Europe will remain strong players in the coming year because of the overseas domination by banks. Some of that supply from Europe's financial names should "migrate itself into the U.S. [market]," he said.

"It will be robust in Europe," he said. "It should ease off on the industrials. In the U.S., IG doesn't need to issue next year. There will be less industrial supply in the U.S."

October lull eyed

In the nearer term, there will be a lull in deals brought to market in October as earnings season comes. November could be busy, but then issuance will likely die down again, he said.

"I don't think we'll see people jamming stuff out in December. They're going to close the books out early. BBB spreads are still dislocated. They're wider than historically. Spreads will tighten but will be [at a] higher yield than Treasuries. The five-year tightened meaningfully. I see people doing three-year, five-year [maturities], not long commitments."

According to Barclays' report on its outlook for the quarter, A and AA rated industrials have "somewhat limited room to rally and could face headwinds from relative value considerations."

The report recommends looking to add exposure to BBB rated industrials and wide-spread financials.

The head of research for Barclays Capital, Larry Kantor, said at Thursday's briefing that they're "favoring equities over credit. We're much more cautious, but we still like risky assets."

Barclays is a financial services company based in London.

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