New issuance brings hope for battered credit market

After months of turmoil, fund managers are beginning to find new opportunities in the credit markets, as issuance of bonds re-emerges following recent relative stability. According to Adam Mossakowski, UK credit fund manager at F&C, and judging by this week's £1bn subordinate 10-year bond deal by Barclays, new issuance is likely to be "aggressive" .

Corporate bonds have been selling off since the beginning of the year over fears of US recession, further CDO/ABS write-downs and the fate and subsequent fallout of monoline insurers. "In February credit spreads decoupled from equities and continued to sell off. Bonds and equities are beginning to price in increasingly divergent outcomes – the former a US recession, the latter a soft landing," Mossakowski explained. "However corporate bond markets have recently stabilised following rumours of a bank led recapitalisation of Ambac and S& P's removal of watch status from MBIA's AAA rating. A break-up of these businesses is still on the cards, but the market certainly appreciates this current improvement in sentiment," he said.

High yield has so far been the worst performing part of the market this year. While valuations have cheapened significantly, spreads are not yet at levels seen in previous recessions. The current average spread on the Merrill Lynch BB-B European Currency Issuer Constrained High Yield Index is 673bp, versus 485bp at year end 2007, and 208bp at end Jun-07. "However, when the same index returned 25% in 2003 and 13% in 2004 spreads were 809bp and 366bp respectively at the beginning of each year," he noted. "Although we remain defensive for the time being, we have been buying bonds opportunistically where there has been distressed selling of otherwise sound businesses." Bonds recently bought by the Strategic Bond Fund include global beverage packaging company Rexam and Central European Distribution Corp, a Polish vodka distributor.

Issuance of investment grade bonds has been thin since the credit crunch began, turning "anaemic" over the last two months. "However Barclays was quick to jump on the relatively stability of last week, issuing a sizeable £1bn deal which will be the third largest bank bond in the iBoxx Sterling index," he explained. The fact they could get this deal done shows two things; the willingness of issuers to cheapen deals to get them done – the bond came at a generous discount to secondary market levels and 3.5% over the equivalent maturity Gilt, and that there is appetite for bonds at the right level.

"The deal was cheap, an effective yield of 8.25% for 10 year investment grade bank paper, and this re-priced existing bonds in the secondary market where we added to our position in Barclays." Mossakowski added that other issuers, including Lloyds TSB, Allianz and McDonalds, were also lining up to bring bonds to the market.

"As the leverage unwind continues, we remain defensive in high yield but are increasingly seeing value on a name by name basis. Also, we look to build on our overweight in investment grade financials as and when issuers are forced to come to the market at sizeable discounts," he concluded.