Tesco bonds shrug off downgrade to junk

* Moody's downgrade prompts little movement in bonds

* All eyes on S&P, which could cause index move

* Property bonds hit harder

By Robert Smith and Anil Mayre

LONDON, Jan 9 (IFR) - Tesco (Xetra: 852647 - news) 's bonds traded up on Friday morning despite the company losing its prized Moody's investment-grade credit rating, although the recovery might be short-lived if other rating agencies follow suit.

Tesco's largest euro deal, a EUR1.25bn 1.375% 2019 issue, widened from mid-swaps plus 201bp to 251bp on Thursday morning as jitters around a potential downgrade spread.

However, the rout did not last and the bond closed at 226bp. It has snapped even tighter since to plus 196bp.

"It's very common for bonds to trade off until the agencies junk, and then start to appreciate again after the fact," said a bond investor at a large UK asset manager.

The downgrade was largely expected. A high-yield investor said there was a rumour on Thursday morning that Moody's would lower Tesco following an investor meeting that began at 1130 GMT.

The rating agency waited until late on Thursday evening to cut its rating by one notch to Ba1 with a stable outlook.

While Tesco's bonds may have shrugged off one downgrade to junk, the reaction could be more painful if other agencies follow Moody's lead. That would push the debt into high-yield bond indices, which in turn could cause forced selling.

Tesco's CFO said during the investor meeting that he had spent many hours with all three rating agencies outlining its new strategy the previous day.

Fitch maintained its BBB- rating on Thursday, but still has a negative outlook due to the "significant execution risks" around the new strategy.

This puts the spotlight on Standard & Poor's, which has the company's BBB- rating on CreditWatch Negative and has yet to make public its assessment of Tesco's turnaround plan.

"S&P seems to have been a bit more generous so it's more of a coin toss, but if they follow suit then you might see technical selling begin in earnest," said the first investor.

"Long-only sterling investors such as pension funds are up to the gills in Tesco paper, and this is a lot of debt for high-yield investors to digest. It also has an unusual bond structure for a high-yield issuer with a lot of property backed debt."

He added, however, that Telecom Italia (Other OTC: TIAJF - news) 's move into the high-yield indices in 2013 went far more smoothly than most had expected.

Tesco has 6bn outstanding of euro corporate bonds and £3bn in sterling, according to Tradeweb, together with just over £3.5bn of property bonds under the Tesco Property Finance programme.

PROPERTY BONDS SUFFER

Some of those property bonds have been knocked back by the downgrade.

Tesco Property Finance 6's £493m 2044 bond, for example, was bid at a cash price of 95.875 on Thursday morning, but had dropped nearly 10 points to 86 on Friday.

"The property deals have been badly hurt as they are largely owned by less active pension and life insurance funds in buy-and-hold mandates," said an investor at a small UK asset manager.

"Being dinged to high-yield by Moody's means forced selling for the time being under those mandates." (Reporting by Robert Smith and Anil Mayre, editing by Helene Durand and Julian Baker)