RISK MANAGEMENT | 24 AUGUST 2021

Where Next for
Credit Markets?

Absa-CIB-Author

Matthew Duggan/Jonathan Burnett

Heads: Syndicate and Structured Trading

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After a volatile 2020, what is the current state of South Africa’s listed credit markets – and what opportunities exist for issuers and investors?

The year 2020 was a historically challenging one for all market participants. Investors and bond issuers alike watched as charts spiked, graphs dipped and markets reacted to the unfolding economic crisis. “In the markets we saw unprecedented volatility across every asset class,” says Matthew Duggan, Head of Syndicate at Absa CIB. “This was greatly exacerbated by challenging liquidity, which ultimately resulted in the central bank taking action in the government bond market.”

That illiquidity was most apparent in the corporate credit market. “Now, six to twelve months later, there are still elements of that ‘muscle memory’ from an investor perspective,” Duggan says, adding that investors have responded to the crisis environment by requesting longer lead times into primary issuance. “They are no longer willing to participate in what could be deemed to be ‘stale’ financials. Understandably, enhanced credit work is required to participate in this market environment.”

Primary market recovery

Primary markets, which enable issuers to raise new debt, have started to recover in 2021 after a significant drop-off in activity during the height of 2020’s crisis period. But in the face of a wider issuance spread environment, many corporate issuers were initially reluctant to come to public markets for fear of resetting their credit curves. “In the current uncertain economic environment, we are also seeing much greater differentiation from a credit pricing perspective,” Duggan adds. “We expect this trend to continue in the near term.”

One bright spot in all of this is that issuance by banks has been particularly strong and well supported. “As concerns around bank credit quality have alleviated, there has been strong demand and spread tightening for the instruments that reference a lower part of the capital structure,” Duggan says, pointing to the Additional Tier 1 and Tier 2 instruments that ensure a bank’s capital adequacy.

Secondary market snapshot

Meanwhile, Jonathan Burnett, Head of Structured Trading at Absa CIB, says that while secondary market volumes on the JSE were “decent” in 2020, 2021 has seen a slight drop-off. He believes that volatility in the yield curve and a “wait-and-see” approach from investors are contributing factors.

“Bank and high-quality corporate spreads have somewhat retraced the drastic flight to quality tightening that we saw post-Covid,” he says. “Corporate spreads for good names have been tightening, but – speaking in mid-2021 – the jury is still out as to whether this is a sustainable trend for the rest of the year.”

Creating a virtuous circle

Absa sees an opportunity to provide increased secondary liquidity in this space, which would help both issuers and investors. “As a bank we have dedicated more resourcing and balance sheet to the activity of market-making South African corporate credit,” says Burnett. “We hope that this will better price discovery, liquidity and confidence in what we know is a key part of our economy’s capital market.”

Burnett says that a more liquid and efficient secondary market will help arrangers to demonstrate best execution for primary issuance and provide a compelling alternative to the loan market.

“Historically, primary auctions and private placements have provided price leadership compensating for stale mark-to-market levels,” he says. “But we are starting to see a more balanced market emerge as banks and brokers look to generate more trading activity. For example, the recent spread compression for bank capital instruments has largely been a function of exceptionally strong secondary market appetite.”

“Ordinarily, one would naturally use the secondary market as the pricing reference point for any primary activity, but this is impeded by stale pricing and a buy-to-hold mentality on the investor side,” adds Duggan. “We have spent a lot of time improving liquidity from a secondary market perspective, which will help in terms of price discovery. It then becomes a virtuous circle, where investors feel confident around the functioning secondary market, which is a massive benefit in terms of our ability to encourage issuers to come to the primary market.”

Absa-CIB-Author
Matthew Duggan/Jonathan Burnett

Heads: Syndicate and Structured Trading

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