Tinned food? Check. Bunker? Check. Emergency smokes? Check.
Rolex watch, Toblerone, fondue kit, cuckoo clock? Check.
There’s a very Swiss theme to this week’s European Credit Alpha note from Barclays Capital. That’s because it offers an intriguingly designed safe haven for investors who might fear a resurgent European sovereign debt crisis will smash up credit spreads again.
Presenting the bullet-proof Swiss corporate bond (emphasis ours):
The deterioration in European sovereign credit quality has weakened the euro, caused euro-denominated credit to underperform global comparables, and increased the credit spread volatility of euro bonds. This has led investors to seek refuge in alternative markets to European high grade, such as high yield and emerging market bonds. In our view, non-euro European bond markets stand to benefit from this dynamic as well. In this context, we highlight the Swiss corporate bond market, which, in our view, is a compelling safe haven amid what we expect to be ongoing bouts of sovereign-led credit spread widening for years to come.
Not a massive surprise that Switzerland should be seen as a safe haven in general, of course. But as a nuclear bunker for the specific crisis facing the eurozone’s riskier sovereigns, and the specific way in which corporates bear the brunt of sovereign credit stress, there’s a fascinatingly apt architecture to this one.
As Barcap point out, the Swiss bond market is almost identical to its euro cousin, except for a few key (sovereign) differences.
First, financials loom large in both markets — but in Europe, government bonds loom much larger than in Switzerland (click to enlarge chart):
Which, at a very fundamental level, helps get rid of those pesky sovereign-bank credit loops, we’d say. Second, Barcap add that there’s a difference in the domiciles of bond issuers as well:
…93% of CHF bonds are domiciled in AAA countries versus only 79% for EUR bonds. We believe this is a very significant difference; domicile has been the single most important driver of performance for European credit since Q4 09.
However, there is also one important non-sovereign difference. Swiss non-financials receive much better ratings than their euro neighbours (click to enlarge):
But as Barcap observe, sovereign risk effects predominate even over the credit quality of individual names (emphasis ours):
CHF-denominated bonds outperformed EUR bonds as concerns about the achievability of fiscal consolidation and the magnitude of sovereign funding needs grew. We would venture that similar outperformance will be seen in a renewed bout of sovereign-led widening…
One might argue that investors in similarly high quality EUR denominated bonds would also have outperformed – ie, that CHF outperformance is due solely to being lower beta. We believe this is not true. In fact, tight spread, low beta, “high quality” AA credits in the EUR space substantially underperformed BBBs… there is a name-by-name compositional difference between the two universes: notably, much fewer companies in the CHF universe domiciled in, or with substantial revenues deriving from, peripheral countries. We believe this is an important driver of relative performance.
And last, but not least, Swiss corporate bonds aren’t sitting on a currency union currently under sovereign-fiscal strain:
Why not buy Swiss companies that reside in the EUR index? We believe some of CHF credit’s outperformance is due to greater stability in the currency itself – driving inflows to Swiss Franc bonds – combined with somewhat indiscriminate selling of EUR-based assets. In other words, we would expect, for the same company, CHF-denominated bonds to outperform EUR-denominated bonds on a beta-adjusted basis during a peripheral-sovereign sell-off…
Fascinating, as we said — because the Swiss safe haven shows that we’re really left with not a two-tiered but rather a three-tiered credit market on the continent nowadays. Tier three — the likes of Spain or Greece; tier two — the likes of Germany; tier one — Switzerland.
But what’s interesting is that despite the attractions of a mountain retreat, Barcap believe that current triggers for a fresh European crisis — Ireland, say — have been plugged by ECB intervention. For now. As they observe (emphasis ours):
The Irish sovereign has no liquidity issues. Our economists estimate that Ireland has already performed 94% of its 2010 issuance; indeed, its Treasury has stated that it is fully funded until mid-2011. Ireland outperformed other peripherals in H2 09 thanks to aggressive austerity measures. Market concerns have focused instead on the health of Ireland’s financial system…
In our view, concerns about the liquidity position of Irish banks are misplaced. Irish banks have been net issuers in 2010 (c.EUR9bn), ahead of their September redemptions. Further, they retain significant qualifying liquid assets that they could repo, either in the markets or at the ECB. This funding will remain available until at least 2011, the current limit of ECB term-repo operations, and perhaps beyond… To the extent that Irish banks remain reliant upon the extraordinary support of governments and central banks, they represent yet another issue deferred until 2011.
And beyond that? At least we’ve heard the Swiss are good timekeepers…
Related links:
The Big Pfffft and the Euro-peripherals – FT Alphaville
The tipping point for Europe’s banks – FT Alphaville
The new safe havens (no, not gold) – FT Alphaville