Tag Archives: Weekly Credit Wrap

Grinched

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Susanna Gibbons, CFA

For the past several Decembers, Investment grade corporate bonds showered investors with positive excess returns. Strong demand met reduced new issue supply, and the resulting yield grab left us all feasting on performance. This year, though, it looks like credit spreads have been climbing the slopes of Mount Crumpit.  Over the past six months, they have gone from around 100 basis points, to about 135, and it’s hard to say whether we’re anywhere near the peak.

Supply has not helped the situation. The market stands at a record $1.2 trillion year-to-date, and Mega deals have hit the market throughout the fourth quarter – Medtronic with $17 billion, Alibaba with $8 billion, Kinder Morgan over $7.5 billion, Becton Dickinson over $6 billion….the list goes on. Most of these performed well (at least initially, on growing concessions) but they have also put a lot of pressure on the market overall as investors try to raise liquidity to participate in increasingly attractively priced new issue. These transactions have, by and large, funded significant re-leveraging activity – whether for M&A, share buybacks, or other capital structure engineering.

KMI and BABA have been notable laggards, particularly over the last couple of weeks. They are most exposed to two of the market’s biggest fears: oil and China. Oil prices below $60 seems finally to have grabbed the attention of the equity markets, which have been shrugging off the mixed-message-indicator since October’s sell-off.  How equities feel about China is harder to say, but the Chinese have not been at all concerned, at least judging by the CSI 300, up about 35% for the year.

We in the credit markets are not so sanguine. While little Cindy-Lou Who of the equity world lies a-snooze in her bed, we know perfectly well that the Grinch is slinking around the Christmas tree snatching up a year’s worth of presents. As excess returns slip away, we just hope that we’re left with a can of who-hash.

The Fall of the House of Usher

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Susanna Gibbons, CFA

Perhaps we started putting nails into the coffin of the corporate credit market a bit too soon. After last week, characterized by high volatility, modest trading activity with poor liquidity, and minimal new issue supply, both spreads and activity seem to have rebounded. Overall, corporate credit spreads have tightened by about 3 basis points since last week’s sell-off. This is still a far cry from June levels, and about even with the start of the year, but the market overall feels a lot less scary.

One probably should be cautious investing around one’s feelings, though, as they are rarely the best guide in decision making. While improved market sentiment allowed the corporate bond market to re-open, ushering in about $24 billion in supply (compared to $6 billion last week), performance has not been all that great. A lot of the deals we checked are flat to wider since new issue, like Ingersoll Rand’s new ten year bond, which priced at a spread of +135, and is now trading 137/133. Verizon’s new 10 year priced also priced at +135, and is also trading 137/33. Verizon’s 20 year fared even worse, pricing at+ 145, currently trading 150/147. Not as frightening as Lady Madeleine of Usher at the door, to be sure, but not exactly the picture of market strength either.

Last week, on the other hand, very few issuers braved the market, and those that did had to pay up for it, to the benefit of investors willing to step in. JPMorgan issued $2 billion of a 5 year bond last week at +100, and those bonds are now trading 88/84; General Mills priced a 5 year at +80, now trading 77/72. Apparently it is better to buy credit when the market is a little shaky.

This is not exactly a mystery insoluble – the notion that one should buy risk when getting paid to take risk. It is oh-so-hard to implement, however, as we are always tempted to let our bets ride just a little bit longer. Yet when we step back and look at the current market – how far it has come over the past few years, and the level of risk for which we are now being compensated – we are inclined to take less credit risk rather than more. We may still be a little early in declaring the corporate market dead, but it is surely past its prime. One way or another, we think this house will surely fall.

Twenty-Four Little Hours

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Susanna Gibbons, CFA

September was, to be blunt, a terrible month for credit. Rates were higher, spreads were wider, banks were weak, and record-setting supply weighed on the market. The Merrill Lynch U.S. Corporate master was down about 2 points, a combination of rates that were double-digit higher in the belly of the curve, and spreads which were about 10 bps wider. That may be better than small cap equities, but it was the worst month for credit all year.

What seems most interesting is that supply continued to hit the market all month long, to the tune of about $150 billion. It seems that M&A activity has been driving a lot of the issuance. That represents a change in motivation from earlier this year, when borrowers were tapping the market opportunistically. Up until now, many borrowers could pull back in the face of a less-than-rosy market, but now they no longer seem to have that flexibility.

Case in point this week was the Bayer deal. Bayer issued $7 billion in a 6 part deal, sprinkled across the curve out to 10 years. The company was financing its $14 billion acquisition of Merck’s consumer care business. Bayer already had bridge financing from a $12 billion syndicate of banks, but needed to get permanent financing in place. Given the timing, this deal looked on the cheap side, and as a result it performed well through month end.

What a difference a day makes. The Bayer deal has lagged a little bit, but the rest of the market is notably improved. Rates are better, with the 10 year below 2.5%, and spreads have improved on higher secondary volumes. Bank paper snapped back on Thursday morning, and continues to trade well. It may not be all sun and flowers, but the market feels like it has come through an autumn rainstorm. I cannot say whether it will be all rainbows before us, but I think I will enjoy the moment of romance while it lasts.

Since it rarely does.

Nothing is Easy

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Susanna Gibbons, CFA

For most of September, we have been bungling through the jungle of corporate credit. Interest rates in the belly of the curve have risen by about 25 basis points since the end of August, and credit spreads have been leaking wider. The story here is probably more about rates than credit, though. Credit spreads have been following modest weakness in the equity markets, and both have improved this week. The move in interest rates has been much more pronounced, and has mirrored the strength in the dollar.

It doesn’t really feel like an economy where the dollar should be skyrocketing. Housing trends, employment growth, and general economic activity are all on the anemic side. We wouldn’t call them bad, but they certainly aren’t booming. So maybe it isn’t the dollar skyrocketing, maybe things everywhere else are cratering. Europe continues to be weak, putting further pressure on the ECB to take anti-deflationary action. Japan’s strategy of promoting inflation seems to be geared primarily towards weakening the yen. Russia is struggling with economic sanctions brought on by its extracurricular activities in the Ukraine. And finally, we had the British Pound, beaten down by concern over the Scottish Independence vote.

The Scottish question had implications well beyond the Moors, for Northern Ireland, the Basque region & Catalan to name a few. As the Euro still looks shaky in its loose confederation, many countries seem to be asking to what extent independence should be pursued rather than unity. The markets clearly prefer the stability of unity, and hope that the currencies in question have strapped on their aqualungs to survive what they hope will be temporary plunges. It was a new day yesterday, as the No votes prevailed.

Corporate bonds have probably been impacted by the locomotive breath of continued heavy supply, which abated somewhat this week. Total new issue was around $20 billion, led by $2.5 billion from Mizhuho across 4 tranches, $2.0 billion of long and very-long paper from Teachers, as it funds its acquisition of Nuveen, and $1.75 billion from Humana. None of these deals have done all that well, with spreads moving a little wider. Even though the market felt better today, it has not been a great week for credit. It’s just hard to know whether a benign credit environment will continue to prevail, or whether we will find ourselves skating away on the thin ice of a new day.

With apologies to Ian Anderson.

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.