Sunday, October 24, 2010

Weekly Credit Strategy Update : Spreads are unchanged from last week

 Spreads are unchanged from last week
 Reporting season has kicked off in the Nordic countries

Market comment
Activity in the secondary credit market is levelling off a bit. Whether this is merely a reflection of Northern European investors enjoying their autumn holiday remains to be seen, but if activity does not pick up next week it is likely that the rest of the year will be rather quiet.

As we briefly mentioned in last week’s update, US banks are once again in the limelight, as concerns are spreading that some banks could face a requirement from investors to buy back securitised mortgages. The reason for this uncertainty is that it appears that a number of banks have not ensured that the foreclosure processes have been handled in a way that is in compliance with the legal requirements in the bond documentation.

Consequently, several banks have now frozen foreclosing on defaulted homeowners until there is more clarity on the processes. In particular, Bank of America has been hit, with its share price falling and CDS spreads increasing. This is due to its acquisitions of Countrywide and Merrill Lynch amid the financial crisis, as these two institutions were heavily involved with originating and securitising mortgages. We think that these developments are worth paying close attention to going forward. For now, we consider it to be first and foremost a US problem and do not see contagion to Europe as a significant risk.

In the Nordic region, the Q3 reporting season is well under way. For banks, the reports from Handelsbanken and Swedbank have both been sound from a credit perspective, with Swedish asset quality continuing to show stellar performance. In the corporate segment, the reports from Fortum and SKF have also been on the strong side. For the latter, the positive report was somewhat overshadowed by a USD1.0bn bid for Lincoln Holding which, if successful, will weigh on credit metrics. We think that the example of SKF is fairly representative of the credit situation, where we are approaching a phase in which companies will start taking more shareholder-friendly actions, whereas in the last few years the focus has been heavily on the balance sheet.

The investment grade index, iTraxx Europe, currently trades at 101bp and the high yield index, iTraxx Crossover, trades at 465bp. This is largely unchanged from last week.

The primary market
In the primary market we continue to see reasonable activity including a few high yield bonds. Going forward, we think the European high yield market will grow in importance as bank lending standards remain tight in Europe and forthcoming regulation efforts will curb lending capacity. Refinancing of bank facilities in the capital market might therefore prove to be an attractive option for several companies.

In the short term, a surge in SEK-denominated issuance seems likely on the back of a sharp increase in the SEK/EUR basis swap. This makes issuance in SEK relatively attractive compared with issuance in EUR and we would expect a number of issuers to try and take advantage of this.

Full report: Weekly Credit Strategy Update

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