Half year review: strong demand and tighter spreads

Primary Market activity: Low activity as expected, with strong demand

The primary market activity in the second quarter slowed significantly, with gross issuance of bonds and commercial paper (CP) declining by 47% to R29.2 billion, compared to last quarter’s issuance of R55 billion. However, the lower market activity is in line with the historical observations which typically see a softer second quarter. The issuances were dominated by corporates and financials, with net issuances of R12.8 billion and R15.0 billion, respectively. Municipalities and state-owned enterprises (SOEs) did not issue any new instruments in the quarter under review.

Figure 1: SA credit market issuances in the first half of 2023

Source: SBG research SA corporate bond market overview June 2023 – 1H23 in review

In the first quarter of 2023 the gross issuance of bonds and CP reached a total around R55 billion (about a 15% increase compared to the previous quarter) and a substantial 73% increase year on year. This growth was primarily driven by the financial sector, which issued about R22 billion of bonds (down 5% quarter on quarter but up 49% year on year), and SOEs, which placed close to R20 billion of bonds (up 163% quarter on quarter and 93% year on year). Among the SOEs, Eskom emerged as the largest issuer in the quarter, placing R16 billion.

During the second quarter, local primary market subordinated (Tier 2 and Additional Tier 1 (AT1)) bank instruments bounced back with a total issuance of R6.5 billion, up from R4.8 billion from the first quarter which, in our view, was suppressed due to the write-off of Credit Suisse AT1 notes during March 2023. Key issuance during the second quarter was First Rand Bank, who issued R2.5 billion Tier 2 notes at 3M Jibar + 188 basis points (bps) - marginally contracting from February 2023 issuance at 3M Jibar + 190bps - while Standard Bank also issued R2.5 billion AT1 at 3M Jibar + 338bps, contracting from 3M Jibar + 350bps at the last issuance in November 2022. Notwithstanding the subordinated bank spreads widening offshore following the banking crisis, the South African market for similar instruments has seen spread compression, due to a continued search for yield, in our view.

Corporate issuances picked up in June, adding some activity to a slow quarter. Both Daimler Truck Southern Africa and MTN dominated issuances during the month, raising R1.5 billion and R2 billion, respectively through public auctions. These auctions were well supported, with bid cover ratios above 2 times and clearing spreads below guidance (except for Daimler’s 1-year note which issued on the lower end of guidance). Other issuers such as Barloworld and Super Group opted for private placements, while Growthpoint accessed the market through a bookbuild, raising R1.35 billion across 5-year and 7-year notes, with both notes clearing below guidance. The 7-year note attracted the most demand with a 2-times bid cover ratio, with a total of R796 million issued for this note. Strong demand across all issuers continued to be a dominating theme.

Secondary Market activity: Slight compression across the board

According to data provided by Standard Bank Securities, trading volumes marginally increased by 2% to R32.9 billion in the second quarter, with an impressive 29% increase year on year. The trading activity was dominated by the financial sector at 58% followed by corporates at 28%. Negative sentiments towards Municipalities and SOEs continue to reduce the volume of secondary market trade from a 17% contribution in the first quarter to 10% in the second quarter.

When examining the spread movements in the secondary market, we continue to see a slight compression across all issuers during the quarter.

Credit pricing: A tightening trend

In the second quarter of 2023 credit pricing showed a notable trend of tightening, mainly driven, in our view, by an increase in demand for credit. During this period, the floating rate notes (FRN) senior funding curve of banks compressed by approximately 15-20bps across the 3–7-year maturities, in relation to the levels in the fourth quarter of 2022. This compression was also evident across the entire capital structure. For example, the spread between the AT1 bonds and 5-year senior bank notes averaged about 3.5 times during the five-year period from 2017. However, from 2022 onwards, this average basis reduced to approximately 2.5 times, as can be seen in Figure 2 below.

Figure 2: Relative subordinate bank spread trends since 2017

Source: JSE, Absa Research

Interestingly, since 2022, we have observed a growing number of new investors entering the AT1 trade. The enticing yield on offer, coupled with improved liquidity in the AT1 market, has fuelled this increased demand. As a result of the heightened interest, we expect the demand for bank credit to persist, potentially leading to further spread compression.

 During first half of 2023, both Tier 2 and AT1 notes experienced significant spread tightening, reaching record lows of 188bps and 338bps over 3-month Jibar, respectively. This occurred despite initial concerns earlier in the year due to the Credit Suisse write-off. The strong interest in these notes was evident through oversubscribed auctions.

 Recently, FirstRand successfully issued R1.4 billion in AT1 paper at a spread of 310bps over 3-month Jibar, which falls within the mid-range of our valuation analysis. From our perspective, these valuations appear to be quite stretched compared to historical levels. However, this could also indicate that the AT1 market in South Africa has matured, with numerous participants providing improved liquidity and price discovery. It's important to consider the unique risks associated with AT1 notes, such as their perpetual nature, the waiver of dividends, and their deep subordination to senior paper, which can have an impact on market dynamics.

Corporate credit spreads for AAA national scale rated High Quality Liquid Assets (HQLA), including auto manufacturers and diversified industrials, entities have experienced tightening in line with the movements seen in bank senior spreads. For AA rated corporates, the spread compression has been less significant, with reductions of around 5bps to 10bps for 3-year and 5-year notes, respectively, recorded so far in 2023. Based on our analysis, it is likely that corporate credit spreads could remain anchored at these levels or potentially tighten further in the future due to increased demand.

 Looking ahead: our expectations

In the second half of 2023, we anticipate a rise in issuance volumes from both banks and corporates, due to the significant maturities that are coming up during this period. However, it is likely that some of the issuances seen in the first half of 2023 were for prefunding purposes.

 Pricing dynamics have been favourable, leading to tightening spreads in both banks and corporates. This tightening has been driven by the robust demand observed in public auctions. Given the sustained interest from investors, there is a possibility for further spread tightening.

 In the case of corporates, pricing trends will largely depend on the individual issuer. We believe that we may see a mix of issuers experiencing tightening spreads or maintaining their current levels, depending on their specific circumstances.