Whether you are looking to understand how to value an intercompany loan for Transfer Pricing, you need to benchmark a particular company among its peers, or you need to value a Corporate Bond, finding the most reliable information is difficult - especially when something unexpected happens.
Let’s take a topical example; Brexit. Will they? Won’t they? Yes. They. Did. But how did this affect the spreads and yields for 10yr BBB-rated Financial Institution debt over this time?
After the Brexit vote, we found that:
- Bond Yields for GBP denominated Corporate debt increased by 7.1%
- Credit spreads for GBP denominated debt increased by 19.3%
- Bond Yields for USD denominated Corporate debt decreased by 0.2%
- Credit spreads for USD denominated debt increased by 7.5%
- A further drop in pound sterling against the U.S. dollar and most other currencies
- Negative consequences for the equity and credit markets, which are already showing an anticipatory effect
This screenshot taken from the S&P Capital IQ desktop shows the YTD trend for 10-yr BBB Financial institutions denominated in GBP. We can clearly see the dramatic increase in Yields in the run up to the vote on 23rd June 2016, rising 23bps from 3.22% on 16th June 2016 to 3.45% on 24th June 2016. What we also see in this same period, is that credit spreads remained relatively stable at around 200bps and its not until the day after the vote we see a 30bp spike in credit spreads from 197bps to 227bps, reaching a peak a full week later at 235bps. This is interesting because for two days, we see both yields and spreads rising.. After this we have seen both yields and spreads decline as the immediate shock subsides. This increase in yield would have a dramatic effect on the interest rates used for intercompany loans. For example, on a nominal $1m loan the difference in interest would be $230,000 per year for a loan issued on 16th June 2016 vs a loan issued on 24th June 2016. Understandably, one would normally use an average to ascertain the interest rate. If we take June as an example, the average yield was 3.3%. Having this level of detail is crucial to being able to justify the interest rate applied to a loan and can lead to considerable cost savings.
It is interesting to see how this affected Financial Institution yields and spreads issued in other currencies. By using the same chart we can compare what happened with the GBP against USD denominated bonds. Again looking at the same highlighted section we can see yields in USD denominated debt immediately declined from 3.79% on 23rd June to 2016 3.71% on 24th June 2016. We also see a 16bp rise in credit spreads from 213bp to 229bp. It is also interesting to note that typically the spread differential between USD denominated and GBP denominated financials debt is around 30bps. However, in February and around the time that the Brexit vote was announced, GBP spreads rose to be at the same level as USD spreads. This occurred again after the Brexit vote with GBP spreads moving higher than USD spreads for a number of days before moving back below. Currently they are around 15bps below USD spreads.
Regulations such as IFRS 13, Basel III, Solvency II and FASB are putting pressure on market participants to provide more transparency around the derivation of bonds prices, particularly for the most illiquid. It is key that you are able to see all of the bonds used in the creation of each curve as shown above. This depth of detail provides all of the information required to justify values used and to fully understand how peers compare to each other in the marketplace.
No doubt there is more volatility to come as uncertainty around the impact of Brexit remains. However, having robust daily curves with full transparency, it becomes a lot easier to be able to reach a decision on an interest rate to be used for intercompany financing and to clearly see how comparable companies are performing in the marketplace. You are always able to keep completely up to date with the current Yield and spread trends for any sector you are interested in.