Creditflux Newsletter

After several years in the spotlight the credit market is no longer centre stage. As issues affecting corporate and structured credit have been resolved by state intervention and the passage of time, attention has shifted to governments, interest rates and tax raising.

In the meantime, many investors with unconstrained mandates have begun looking at the yield on credit-story sovereigns and are choosing to sell corporate credit to buy sovereign debt.

As one respected asset manager said to Wolseley: “What is the point of me analysing the relative credit strength of a glass company and a cement company when what happens to them pales into insignificance compared to the currency and interest rates moves?”

As a result, corporate borrowers will find themselves increasingly competing with government debt issues for the attention of investors. This is “crowding out”; a reduction of private sector investment caused by an increase in government investment. And crowding out not only of investment dollars or euros, but of credit market resources.

As sovereigns look to broaden demand for their bonds, they will increasingly look to use the infrastructure of the credit market. Syndicating issues works well, but as more sovereigns look to syndicate their bond issues and support them with research, so bank resources, which would have been mobilised to help recapitalise banks, will be diverted to reinforce the sovereign teams.

Similarly, research resources are being diverted from contemplating the impact of capex on free cash flow to the nature of the United Kingdom’s guarantee of various government agencies. It can’t be long before we will read research that begins: “The United States is a republic of 50 states founded in 1776...”

Potentially even more worrying than a busy tone when you dial your syndicate desk is the relative regulatory treatment of public sector and private sector debt. Recognising the need to find buyers for large amounts of government bonds and the objective of ensuring a less risky, more robust banking system, our regulators must be sorely tempted to find mechanisms to encourage, persuade or coerce banks into owning more “risk free” government debt.

Wolseley is reminded of the fashion for Korean debt in the run-up to the country becoming a member of the OECD in the 1990s (when OECD membership would reduce the risk weighting for banks owning Korean paper). Korea issued so much paper that the market spent a year-end wondering whether it was going to default before it joined the OECD.

Some of the “credit tourists” who joined us from other markets for last year’s rally are selling up and moving back home to equity- or convert-land, or wherever else they came from. They joined us because, in 2008, we drove spreads to such a wide level that it took non-credit investors to recognise the closest thing to a one way bet the credit market has offered in generation.

Good luck to them. But the excess returns the credit tourists sought have been made. Whilst there remain many excellent opportunities in the credit market, it will take hard work and dedication to realise returns that will be lower than last year. Relative value and absolute return approaches will be required.

For credit investors it’s time to get out of the limelight and back to the coal face – even if a full investment analysis of Greece requires skills that are not normally our bailiwick.

Wolseley is a leading practitioner in the credit market. Feedback is welcome at wolseley@creditflux.com