Category Archives: Weekly Credit Wrap

Let It Snow

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Predictably, the weather outside has turned frightful. We’ve been hit by the first real storm of the season with snow, ice, temperatures below zero, higher interest rates….

Okay, if you’re looking at interest rates, this is arguably at least the second storm of the year. But unlike last summer, the Credit markets are taking this winter storm in stride. 10 year government rates are higher by 13 basis points, while excess returns for credit are modestly positive month-to-date. We’ve seen a little weakness in finance, but nothing significant, and a little bit of strength in the industrial sectors. The new issue calendar has remained solid, with over $26 billion in supply for the first week of December, and deals are performing reasonably well.

There were two “AAA” rated issuers in the market this week, which is unusual since there are so few “AAA” rated issuers left. Microsoft brought $3.25 billion across three tranches in the U.S., and about €4 billion in Europe, while Johnson & Johnson brought $3.5 billion across six tranches. Lower quality issuers such as Thermo Fisher ($3.2 billion) and CVS ($4 billion) tended to outperform the AAA deals, suggesting that risk appetite for credit remains in place. One thing we’ve noticed, though, is that risk appetite is different across the yield curve. 30 year deals have outperformed, and shorter deals have also done pretty well, but new issue 10 year bonds have lagged. So if there’s one place where risk appetite is waning in credit, perhaps it’s the belly of the curve.

But for now, owning credit seems like the investment equivalent of sitting next to the fireplace wrapped in a warm blanket. Let it snow, let it snow, let it snow…..

Love Me Tender

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Credit had a much better week, pushing month-to-date excess returns solidly into positive territory. Spreads held in even as Treasury bonds sold off following the release of Fed minutes on Wednesday. Supply has continued to be very heavy, with over $33 billion of new investment grade offerings. Deals also seem to be performing better this week than last. For example, Coca-cola Femsa (the largest Coke bottler globally) brought $2,150 million of a 3 part deal; the 10-year tranche priced at a spread of +135, and is trading 10 basis points tighter on the bid side.

The interesting question for us is why? After languishing for two weeks, in the midst of a week where taper fears were re-ignited, and when spreads are already trading at the tight end of their post-crisis range, what is pushing spreads tighter? While it is possible that regular readers of the weekly credit wrap noted that we called the end of the financial crisis a few weeks ago, and are responsible for driving spreads tighter, we think there is more at work here.First, volatility (as measured by VIX) has moved lower, and even with the move higher in rates, credit spreads generally respond favorably to a lower-vol environment.

Second, corporations have been active in tendering for outstanding debt, and this reduces net supply. There have been about $15 billion in tenders so far this quarter, and this provides a nice boost for the market. This week, Mondelez announced an offer to purchase up to $1.5 billion of outstanding high coupon debt, at spreads inside of where bonds were trading.  Companies will engage in tender activity in order to reduce high coupon debt, which will generate a loss in the current year, but reduces interest expense going forward. For total return investors, it is just a gift. You want to pay how much for my bonds? Ummm…okay. We love tenders. And we always will.

Credit had a much better week, pushing month-to-date excess returns solidly into positive territory. Spreads held in even as Treasury bonds sold off following the release of Fed minutes on Wednesday. Supply has continued to be very heavy, with over $33 billion of new investment grade offerings. Deals also seem to be performing better this week than last. For example, Coca-cola Femsa (the largest Coke bottler globally) brought $2,150 million of a 3 part deal; the 10-year tranche priced at a spread of +135, and is trading 10 basis points tighter on the bid side.

The interesting question for us is why? After languishing for two weeks, in the midst of a week where taper fears were re-ignited, and when spreads are already trading at the tight end of their post-crisis range, what is pushing spreads tighter? While it is possible that regular readers of the weekly credit wrap noted that we called the end of the financial crisis a few weeks ago, and are responsible for driving spreads tighter, we think there is more at work here.

First, volatility (as measured by VIX) has moved lower, and even with the move higher in rates, credit spreads generally respond favorably to a lower-vol environment.

Second, corporations have been active in tendering for outstanding debt, and this reduces net supply. There have been about $15 billion in tenders so far this quarter, and this provides a nice boost for the market. This week, Mondelez announced an offer to purchase up to $1.5 billion of outstanding high coupon debt, at spreads inside of where bonds were trading.  Companies will engage in tender activity in order to reduce high coupon debt, which will generate a loss in the current year, but reduces interest expense going forward. For total return investors, it is just a gift. You want to pay how much for my bonds? Ummm…okay. We love tenders. And we always will.

Thrift Shop

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For weeks we have been complaining about the lack of supply in corporate bonds, while spreads continued to grind in. We take it all back. Supply has returned to the credit market, with about $60 billion issued over the past two weeks, and month-to-date returns are negative – both total returns and excess returns. Intermediate Corporates have outperformed; they are closed to flat on both metrics. Long Corporates have gotten crushed. Most of the performance has been driven by changes in interest rates, but long credit spreads are wider too.

On top of that, the new deals are not even performing that well. There are some exceptions, of course, like the Thompson Reuters Deal that came this week. They brought $1.5 bill across three tranches, and it was priced to move. The company is engaging in debt-financed share buybacks, which is the bane of the credit world, so they had to price it well to entice buyers.  30 year bonds (the smallest tranche) are 10 basis points tighter, 10 year bonds are about 15 basis points tighter, and even the 3 year did well. Those bonds priced at Treasuries +90, and are trading about 13 basis points tighter. No, the credit market doesn’t like debt-financed share buybacks. Unless the bonds are expected to perform. Then maybe we’ll wave ‘em in.

Even though a few new issues have done well, most of the deals from the past couple of weeks are trading at spreads flat to new issue, or wider. Demand is still strong for a well-priced deal, but concessions have all but disappeared in much of the market.

So forget about supply, right now we’d rather be poppin’ tags in the thrift shop of the secondary market for corporate bonds. I’ll buy your granddad’s bonds. They look incredible.

Call Me Maybe

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Investment grade credit had a good month – the corporate benchmark was up almost 1.5%, and excess returns were positive by 83 basis points. Interest rates and bond spreads tend to be negatively correlated, so we don’t normally expect a month where both help performance. For October, though, fading expectations for a Fed taper really helped interest rates and riskier assets alike. Financials outperformed on an excess returns basis, as they have all year, and the longer duration the better. Most of the positive performance this month came in the few days after Congress’s debt ceiling deal. Spreads are now more than one standard deviation below their mean for the past 12 months. I can’t say that means they’re overvalued – the range of spreads is getting pretty narrow, and one standard deviation over the past year is just 5 basis points.

What I can say is that we think risk-taking probably ramps up a bit. As mentioned last week, we are entering that phase of the credit cycle. From a credit standpoint, TMT continues to look like the hot spot. (TMT refers to Telecom / Media / Tech. I think that might be a credit-only moniker). Whether it’s a rumor about an AT&T bid for Vodafone or a buyout of Time Warner Cable, the sector continues to come under pressure. Media spreads are wider year-to-date by about 30 basis points, making it one of the few sectors with negative excess returns for the year. Some of the transactions being contemplated actually do seem a little crazy, but it sure feels like there are a few connections just waiting to happen.

Issuers came back to the market this week, bringing about $23 billion in supply. Coca-cola was the biggest, with a $5 billion, 5 tranche deal. KO is one of the few AA-rated issuers left in the market, and their deals are generally well received. Not to be outdone, AA-rated Procter & Gamble brought a $2 billion deal the next day, also well received. On the other end of the spectrum, Altria Group (rated Baa1/BBB) was in the market with $3.2 billion of 10s and 30s.  Next week, we are expecting more of the same, with probably $25-30 billion of supply expected.  It looks like we are setting up for a pretty ordinary month. Maybe.

A Horse with No Name

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It looks like we will end this week with negative excess returns – just barely, as spreads have moved around in a fairly directionless market. Part of the issue, from our perspective, is that the current credit cycle is getting a little long in the tooth. Credit regularly goes through a boom and bust cycle. Corporate debt levels expand (slowly at first, then rapidly as companies face an earnings shock) and contract, while credit spreads tend to follow this cycle. Right now, revenue growth at most companies is lagging earnings growth, and that is precisely the time management teams turn to higher leverage to boost shareholder returns — which will eventually push credit spreads wider. But spreads can move sideways for quite a while, generating solid excess returns. The challenge for credit investors right now is to figure out which horse they’re riding.

It has continued to be a bit of a desert with respect to new issue. We had another light week, with just about $12 billion in supply. Following earnings releases, a few banks came to market – Wells Fargo brought $3.5 billion of 5s and 30s, Citigroup did $2 billion of a senior unsecured 10 year, while Bank of Nova Scotia and Suntrust were both in the market with 5 year deals. The Wells Fargo 5 year was probably the star of the week – the deal was well oversubscribed, priced at a spread of 85bps to Treasuries, and is trading about 10 tighter. The Citigroup deal is the laggard for the week, trading a few basis points wider. Continue reading →