Category Archives: Weekly Credit Wrap

Back to School

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Susanna Gibbons, CFA

After snoozing through the last few weeks of summer, it was time to get back to business, and the Corporate Bond market wasted no time in going to the head of the class. Investment Grade supply over the past week was huge, with $45 billion in new issuance (and well over $50 billion if you included all the sovereign issuers). Over 70% of the deals were in the bank and finance space. Bank of Tokyo – Mitsubishi UFJ and its partially-owned stepchild Morgan Stanley were among the two largest issuers, bringing about $3 billion, and $2.25 billion, respectively. There were also big deals out of Bank of New York, Wells Fargo, Lloyds Bank, Standard Chartered… even little Fifth Third Bank of Cincinnati did an $850 million bank note deal.

As a result of the heavy supply, the secondary market was forced to absorb a fair amount of paper, and this pushed spreads a little wider, especially in the Bank / Finance space, which saw about 3-4 basis points of widening on the week. Not a huge change, but enough to put spreads at the wide end of the very narrow, 5-10 basis points range where they’ve been stuck for most of the summer.

In all the excitement, we almost forgot JPMorgan. JPM issued $3 billion of subordinated holding company debt to start the week. This was a 10 year deal, priced at a spread of +153 (and has traded wider by a few basis points). Even though the FDIC Single Point of Entry (SPOE) rules for a bank holding company debt requirement remain under consideration, we have seen continued supply of bonds which we think might fill some gaps in this area. Depending on how the rules turn out. Which we don’t know yet. Did we miss something while on summer vacation? Banks are not usually big third quarter issuers; it is almost as though they have seen the answers to the test.

So, class, what do you think? Are bank issuers trying to fill their SPOE buckets before the rest of us even know where our new lockers are?

Good answer. Good answer. I like the way you think. I’m gonna be watching you.

Proud Mary

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Corporate bond supply has trailed off to almost nothing. This week we had just $6 billion in new issue, about a quarter of which was from Credit Suisse, as the banks come back into the market post earnings. Credit Suisse reopened two existing bonds, selling an additional $750mm each of the 2.3% 5/28/19 and the 1.375% 5/26/17 at spreads of +70 and +47, respectively. There was just $65 billion in corporate bonds issued all month, and this week’s supply came to an abrupt halt with the equity market sell-off on the last day of the month.

Spreads overall were weaker, backing up 2-5 basis points. Banks and higher risk sectors bore the brunt of it, but weakness was pretty widespread. For the month of July, spreads ended up close to unchanged, and total returns were pretty close to zero – a far cry from the 5.7% for the first 6 months of the year.

We are keeping a close eye on Supply / demand trends in credit right now. We have watched the high yield market suffer significant outflows for most of July, creating selling pressure and driving total returns to -1.33% for the month. We have not seen the same selling pressure in high grade markets, where money continues to come in, but we are wary. The risk-on tone which blanketed the markets through June has given way under the weight of geopolitical pressures, economic uncertainty, and the expectation that higher interest rates are finally right around the corner.

We can’t help but feel that the river of liquidity that has been carrying us all downriver is about to dump us into the Gulf of Mexico. Being carried out to sea on a riverboat would be a vastly different end to the credit cycle than anything we’ve seen before. Everyone is so busy waiting for the river to dry up – the more typical end to the cycle – that perhaps they are missing the bigger risk. As the Fed ends QE, and moves into rate hikes, maybe we will find that shutting off the tap is harder than they thought.

Firework

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As we headed into July 4th, 2013, Investment Grade Corporate Credit did not have a lot of friends. The fear of higher interest rates created all the fireworks, and spurred the market into a flurry of what today looks like a bout of panic selling, which ignited some rather unpleasant spread widening. IG Corps felt a little like a house of cards, one blow from caving in.

We find ourselves in a very different spot today. Spreads are about 50 basis points tighter than a year ago. With the threat of taper now behind us, and the reality of rate hikes somewhere in the future, volatility has remained low and risk-taking has been rewarded. Corporate credit has been one of the market’s star performers, with both spreads and rates rallying, pushing the benchmark up YTD by 5.7%. For us, it was the best July 4th in recent memory, since this was the first June since 2007 that spreads did not widen going into month-end.

The corporate bond market celebrated by taking most of the week off. There was about $18 billion in total new issue, and software provider Oracle was responsible for more than half of the volume, coming to market on the last day of the quarter with a $10 billion transaction spread across 6 tranches. The company will use the proceeds to pre-fund its $4.6 billion acquisition of Micros Systems, a provider of integrated software and hardware solutions for the hospitality and retail industries, as well as for share buybacks and general corporate purposes. Given the size of the transaction, ORCL pricing was attractive across the curve. The ORCL transaction again highlights current market trends around M&A. While we have not seen a significant pick-up in LBO activity, companies are increasingly turning to M&A to boost shareholder returns while taking advantage of attractive levels in the corporate bond market.

IG Corporate performance has so far won out over interest rate fears, M&A risk, slow economic growth – you name it. The sector has shown us all just what it’s worth. While it’s hard to imagine another six months as good as the last, for a brief moment we will just sit back and admire recent history with an ahh…ahh…ahh…

World’s Cup Runneth Over

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Once again, one of the world’s central bankers was in charge of the game. On Wednesday, the FOMC released its much anticipated statement, confirming as expected that the Fed would continue to taper its bond purchase program. Its 2014 growth outlook was slightly lower, but not very negative. If there was any surprise, it came during Yellen’s press conference, when she spooked a few corners of the bond market by dismissing recent inflation figures as noise. This led to a steepening of the yield curve which persisted into Thursday. It seemed to be exacerbated by the 30-year TIPS (treasury inflation protected securities) auction, which didn’t go quite as well as dealers were expecting. Nominal 30 year levels recovered sharply on Friday – but still ended the week higher by about 4 basis points. It seems that the bond market is struggling to figure out the FOMC’s next step. It may be that the FOMC is struggling to figure out its next step.

There was no uncertainty, however, on the part of credit markets, which once again took its cues from a Dovish central bank. Not worried about any increase in inflation, 10 year bank spreads rallied by 5 basis points or so, and higher vol sectors like materials have also had a good week. Utilities felt like they lagged a bit, so data all around showed support for the central bank-induced risk-on trade. The World Cup of liquidity continues to flow.

The new issue market, on the other hand, slowed down this week. Most issuers tried to get in ahead of the Fed, so Monday and Tuesday were the big days, with about 80% of the week’s volume. Total supply this week was just over $20 billion, so a pretty slow week overall. The week had more than its share of energy companies, as Cameron, ERP Operating, and Hess all brought deals to market. The interesting trade of the week was our local friend Target – the company had to widen the price from initial talk in order to get its deal done, which we haven’t seen in a while. The company brought $2 billion total, $1 billion of a 5 year at +60, and $1 billion of a 10 year at +90. These bonds ended up among the better performers on the week, so the initial guidance wasn’t that far off, but the market demanded a concession given the noise around the company’s story recently.

So in the end, we think it was a pretty solid week for credit. Should we be worried about liquidity driven bubbles? Maybe, but I think we’ll just focus on soccer for now. Gooooooooaaaaaal!

Super Mario

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Mario Draghi announced the ECB’s monetary policy actions on Thursday, June 5th, and on balance they were largely as anticipated. Without getting into too many details, the ECB launched a new series of “targeted longer-term refinancing operations”, began to set the stage for certain asset purchases, and lowered a variety of policy rates, including moving the deposit facility to -10 bps. We are not quite at QE in Europe, but they appeared to edge in that direction, and the ECB has made it clear that Deflation is a primary concern for the economy, even though it has returned to modest growth this year.

Credit markets reacted positively to this week’s data, including the ECB actions. Bank spreads seemed to be the biggest beneficiaries, with on-the-run banks tighter by 5-10 basis points. So far this month, we are seeing a complete reversal of last month, with higher rates, a steeper curve, and tighter spreads, especially on the long end. It was definitely risk-on in Europe – in addition to the ECB actions, Standard & Poor’s raised the credit ratings of a number of Spanish Banks, following a hike in Spain’s sovereign rating a week earlier. Rates in all of the peripheral countries in Europe have rallied like Luigi in a go-cart, and are trading at their lowest level in years. Spain and Italy, the two poster children for European chaos, saw rates drop by 20 basis points to 2.6% and 2.7%, respectively – just a hair above levels in the U.S.

The primary market did not wait around to see the data – as usual, the weekly calendar was front-end loaded, as few issuers wanted to take the risk of a bad outcome on the news front. Total supply was about $29 billion, which is a decent week. Large deals included Express Scripts, with $2.5 billion across three tranches, $2.4 billion of shorter paper from American Express, and $2 billion of an AT&T 30 year bond. Most deals are performing well, as most of the spread tightening this week took place on Thursday and Friday. The market is expecting more of the same next week – probably about $25 billion in supply.

There was a range of positive or at least benign data supporting credit markets this week, but we are inclined to attribute most of the rally to the ECB. At least for now, markets are expecting the announced policy measures to act like our own little Yoshi, gobbling up all the bad stuff – slow economic growth, deflation, weak banks – and turn them all into gold coins to toss back to Mario.