Incremental demand for credit is estimated at $429 billion for corporates in 2014, according to a recent research by Citi.
Stephen Antczak and the team at Citi Research arrived at $429 billion for the whole market by considering flows in four sources viz.: Mutual Funds, Pensions, Life Insurance Companies and Corp Treasury Department.
The following graph captures incremental demand for corporates in 2014:
Credit mutual fund flows
Citi analysts point out that EPFR data reveals mutual fund flows in the corporate space have totaled $52 billion through November 2013, driven by inflows of $66 billion in the leveraged loan space. The unsecured space witnessed outflows of $14 billion in high-grade and an inflow of $688 million in high-yield.
According to Citi analysts, two key drivers of mutual fund flows in recent years have been the performance of the equity and Treasury markets. The analysts point out total returns tend to drive flows into / out of credit mutual funds and hence rising Treasury yield would cause outflows, while falling ones inflows.
Citing their equity colleagues’ expectation on the end-2014 S&P 500 at 1900 and their rates strategists’ prediction of 10-year Treasury bonds yielding 3.3% in 2014, Citi analysts anticipate cumulative mutual fund flows since 2009 to be $563 billion at the end of 2014. However, the analysts expect cumulative flows through 2013 should end up at $591 billion, and thus an outflow of $28 billion might be expected over the course of 2014 from credit mutual funds.
Stephen Antczak and team at Citi Research note funded status is an important demand factor for private pension flows at it helps to gauge whether stocks or bonds are more attractive. The analysts point out that all else being equal, the closer pensions are to being fully funded, the greater the willingness of managers to shift portfolio from stocks to bonds to immunize. However, Citi analysts believe at current levels, this metric argues for bonds.
With stocks rallying about 25% in 2013, the analysts point out the average pension asset allocation has been pushed roughly 40% stocks / 40% bonds to 45% stocks / 35% bonds. This is depicted in the following graph:
The analysts believe returning to a more balanced allocation would produce about $100 billion in demand for fixed income and based on past history, 45% would be allocated to credit.
Citi analysts anticipate demand for corporates to be $45 billion in 2014 as a base case scenario.
Life insurance companies
According to Citi analysts, three factors should influence demand for corporates by insurance companies viz.: (1) the overall economic backdrop, which captures people’s ability to buy policies, (2) absolute yields available to be earned within the corporate market and (3) the interest rate that needs to be paid out to policy holders, which could capture insurers’ desire to underwrite new policies.
Citi analysts point out that by considering their economists’ expectation of unemployment at 6.4%, their strategists’ expectations for long corporate yields at 4.45% Treasury with 165 bp credit spread and a slight uptick in crediting rates in the wake of higher Treasury yields at 3.1% from 2.9% currently, the analysts anticipate an increase in incremental corporate demand from insurance companies of $108 billion in 2014.
Corporate treasury departments
Citi analysts forecast demand for corporates to be $25 billion based on the following assumptions: (a) Amount of cash and cash equivalents would grow at 5%, (b) The percentage of cash and cash equivalents being held in the form of cash equivalents would increase by 6%, (c) Among cash equivalents, the split between credit and others would continue to evolve as it has in recent years so that slightly more flows into credit.
Citi analysts conclude that despite the concern of many market participants about various market features including seemingly full valuations, tapering, rising rates and re-leveraging, it appears that the credit market will experience positive incremental demand.