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By Jeremy Glaser | 06-21-2010 10:16 AM

Corporate Credit Spreads Have Room to Tighten

Absent any negative shocks, spreads on corporate bonds should tighten over the coming weeks says Morningstar's Dave Sekera.

Jeremy Glaser: Has the corporate bond market stabilized? I'm Jeremy Glaser with Morningstar.com. I'm joined today with Senior Analyst, Dave Sekera to talk about what's happening with the corporate bond market and what it might be doing in the future?

Dave, thanks for joining me today.

David Sekera: Thank you. Good to be here.

Glaser: So, when we talked last, you predicted that there was going to be an increase in volatility in corporate credit. Have you seen that take place?

Sekera: We've definitely seen that take place. At the beginning of May, when you and I spoke about our expectations for increased volatility, the Morningstar Corporate Bond Index, the spread about that time was, I think, 140 basis points over treasuries.

Since then we've seen the Morningstar Corporate Bond Index widen out all the way to about a 190 basis points over treasuries as of June 10th.

Glaser: So, have we started to see any stabilization, it's been widening, are things starting to calm down a little bit?

Sekera: Yes. We have started to see the stabilization. This week corporate bond spreads came in about 5 basis points. And we really saw the stabilization begin about last Thursday.

Glaser: So, what's been driving, both the increased volatility and now some of the increased tightening?

Sekera: Well, I mean the market had a lot to digest over the last month and a half. We've had the Greek crisis. We've had the contagion into Spain, now we've had a lot of issues about liquidity among the Spanish banks.

Here in the United States, we've had a lot of mixed indicators. We've seen industrial production number still look pretty good and I would consider that to be more of a coincident indicator.  More of the leading indicators haven't totally rolled over just yet, but they're definitely starting to soften here. For example, consumer spending numbers have been coming back down.

Glaser: But on the plus side, we saw Spain was able to actually issue 10 and 30-year bonds, has that bode well for – that maybe the credit fears in Europe have started to fade?

Sekera: That definitely helps. I mean, we still have the credit fears in Spain. We still have the issues with the banks. Europe right now is talking about putting together their own stress tests like we did here in the U.S. for their banks.

Unfortunately, those numbers won't be released until the end of July. So until those numbers come out and the market really is placated, I think, we could still see some blips here and there, but as long as we don't have any real new negative news headlines, I think, that the credit markets will continue to keep grinding tighter from here.

Glaser: So, thinking about opportunities in the credit space, you think that there are places for investors to find some extra yield or to find yield now or should they be more cautious?

Sekera: Definitely. The new issue market has really started to heat back up. If you read last week's Credit Weekly, we talked about how the shadow calendar had been building over the past couple of weeks. Now issuers really don't want to be bringing a large new corporate deal to market when you have all of these negative news headlines out there, so that has been building up.

This week, we've started to see a lot of those issuers tap the market and they've been coming at pretty decent spreads and we've seen those trade-up in the secondary market.

Glaser: What's your outlook for corporate credit over the next coming months?

Sekera: Well, over the next couple of weeks, anyways, which is about as much visibility as I have in this market anymore, I think that corporate credit spreads will continue to tighten in. At a 185 over, that's pretty much about as wide as where they were in September '09. And really since that time period, we've seen corporate credit metrics improve.

For example, corporations have a lot more cash on their balance sheet, debt-to-equity ratios are significantly lower, leverage has come back down. So I just see improving credit metrics helping the corporate bond market and we should see some spread tightening maybe another 20 to 25 basis points here in the near-term.

Glaser: Dave, thanks so much for talking with me today.

Sekera: Thank you very much.

Glaser: For Morningstar.com, I am Jeremy Glaser.

 

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