Sunday, October 31, 2010

Weekly Credit Update

Market comment
We have not got much to report this week, due to it being quiet in terms of news flow for the credit market. CDS indices are slightly tighter with the investment grade index, iTraxx Europe, currently trading at 98 basis points and the high yield index, Crossover, trading at 460bp.

The Q3 reporting season continues. The large Nordic banks that have reported this week (DnB, SEB and Nordea) have continued from where Swedbank and Handelsbanken left off last week, with reports showing improving asset quality. Among the corporates the strong momentum continues – particularly in earnings – and we generally see continued strong cash generation. Cash balances are therefore further strengthened and this further fuels worries about increasing shareholder initiatives (dividends, share buybacks, M&A, etc).

The primary market
The previous week was quiet in terms of primary market activity, but this week has been busier and we have seen several new issues. From the Nordic region, Nykredit Bank has issued a 5Y fixed bond at 135bp over swap that tightened substantially after it was issued.

We recommend a small overweight in credit
For some time we have argued that credit as an asset class has been in the sweet spot. Flows have been supportive as have fundamentals. The big question is naturally how long this can go on. As we see it, the case for further spread tightening is getting harder to argue. On the other hand, neither do we consider a significant widening of spreads to be likely. Thus we mainly see credit as a carry play in the coming quarters. As we think sovereign distress is likely to flare up time and time again – as recently evidenced by Ireland – senior financials are not likely to erase the spread discount to similarly rated non-financial companies. Note, however, that dispersion among banks is significant and likely to remain so.

Overall, we recommend a minor overweight in both investment grade and high yield credit in the coming quarters and we favour non-financials to financials. Looking further ahead we believe that the risks for credit are to the downside as idiosyncratic risks increase and technicals become less supportive.

Full chart report: Weekly Credit Update

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