Monday, 20 May 2019

Any yield in a storm

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  • Any yield in a storm

Despite low interest rates, demand for US investment-grade corporate debt has been unstoppable with US$435.1bn paper sold so far this year.

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The records have been tumbling since the beginning of August. Semiconductor and computer technology company Texas Instruments priced a US$750m August 2015 with a 0.45% coupon. A few hours before that Unilever priced a US$450m bond of the same tenor at the same coupon. At the same time the British-Dutch multinational priced a US$550m five-year with a record coupon of 0.85%.

The volume shows no sign of abating. This year is set to be a record year for US corporate debt issuance. August saw US$42bn corporate issuance, versus US$40.8bn and US$36.8bn in 2011 and 2010, respectively. And year-to-date 2012 is already standing at US$435.1bn versus whole-year figures of US$454.6bn and US$391.4bn for the two previous years, according to RBS.

“Until every company has availed itself of funding at these levels we think that issuance will continue,” said Edward Marrinan, head of macro credit strategy and co-head of Americas strategy at RBS Securities.

The current environment makes it incredibly attractive both for issuers and for investors. For issuers it is a no-brainer. Investment-grade corporate bonds use Treasuries as a pricing benchmark and they have remained low, thanks to liquidity from the Federal Reserve.

Acrophobic levels

As a result issuers have fallen over themselves to set record-low coupons this year right across the curve. The yield on two-year US Treasuries in mid-September was quoted at 0.26% and 10-year yields were only 1.82%, up from 1.40% in August.

Only 18 months ago the yield on 10-year USTs reached an acrophobic 3.652%. Little wonder then that at the beginning of August, IBM sold a 10-year at 1.875% via BNP Paribas, Citigroup, Deutsche Bank and UBS.

One banker said: “Of course companies are falling over themselves to issue. Which company wouldn’t want to cut a couple of percentage points off their borrowing costs?”

There is a wider perspective to the low interest rates that are driving IG corporate borrowing costs. Key is the RBS high yield bond index ex-financials which hit a low of 5.98% on September 14. A year ago it was almost 150bp higher and the lowest figure before then was 6.614% recorded on May 16 last year. Given that investors are being driven by the need for yield, deliberately low interest rates are, what one banker calls, the “unspoken path of central banking policy”.

The knock-on effect of that has been low yields for investment-grade borrowing which in turn has forced investors to look at high-yield investments. Although the transmission mechanisms still need to work their way through, the Fed’s thinking is that this will create more consumption, goods and services.

But low yields are not the sole reason why investors are scrabbling over themselves to get their hands on IG corporate issuance. And make no mistake, they certainly are. Oversubscriptions on new IG US corporate paper stood at just under four times a year ago. Now they stand at around six times according to RBS. Hand-in-hand with that, a new issue premium of around 35bp in October last year has slumped to low digit-single figures now. What is it that is making investors so keen to get their hands on IG US corporate paper?

Losing patience

Bankers said there were several drivers. First is what has become the banking mantra for 2012, the need for yield. Put more bluntly, when 10-year USTs are 1.82%, even a corporate rate of 1.875% can look attractive. An added push has been given by a broader investment trend away from equities. Investors are starting to lose their patience with that roller-coaster.

“Equity markets have remained reasonably volatile, certainly with the euro crisis impacting global economic outlook,” said Brendon Moran, global co-head of corporate origination at Societe Generale. “US corporate debt has become a safe harbour asset class. Earnings have been meeting expectations. On the whole, the corporate sector has been very robust through the ups and downs of global economic activity. It’s got a safe harbour status that investors find very, very appealing.”

But above all, US corporate issuance is benefiting from not being in the euro. The macroeconomic outlook might have stabilised in Europe somewhat, but uncertainties remain. “There has been huge demand from non-US institutional investors,” said RBS’s Marrinan. “The US dollar itself is not in question.”

It is the secondary market that has seen a decline in action. Volumes are distinctly down thanks to two factors. First is new regulations for banks.

“Markets are operating in a new regulatory regime,” said one banker. “There is a higher cost of trading and holding.” The second factor is less obvious. There is a fear that investors will not get back what they have just sold – the demand is so high for IG corporate debt that investors think twice.

Flood of issuance

While there is a consensus that issuance can continue, the obvious potential fly in the ointment is what could happen if there were a sharp rise in interest rates. That could leave investors with egg on their faces and negative returns in their portfolios. Jittery because of what happened in August when 10-year Treasury yields suddenly jumped to 1.84% from 1.47%, in September ahead of the Federal Open Market Committee announcement of its third round of asset purchases aimed at boosting economic growth, there was a sudden flood of issuance.

“US corporate debt has become a safe harbour asset class. Earnings have been meeting expectations. On the whole, the corporate sector has been very robust through the ups and downs of global economic activity. It’s got a safe harbour status that investors find very, very appealing”

Indeed, ahead of that Thursday [September 13] decision, the Monday turned into the busiest day ever for the publicly syndicated US high-grade bond market. Fourteen deals and US$18.95bn debt was printed. The largest US drugstore chain Walgreen, US pharmaceutical firm Merck & Co, the world’s largest offshore drilling contractor Transocean, natural gas distributor ONEOK Partners and Tyco-subsidiary Tyco Flow Control Finance were just five of the names that issued paper that day.

Walgreen alone raised US$4bn from a five-part deal via Bank of America Merrill Lynch and Goldman Sachs with a book size of US$18bn. It sold a US$550m 18-month floating rate note at three-month Libor plus 50bp; a US$750m 2.5-year at UST plus 80bp; a US$1bn five-year at UST plus 120bp; a US$1.2bn 10-year at UST plus 145bp; and it pushed out the curve with a US$500m 30-year at UST plus 165bp.

As it turned out there was nothing to worry about. The Fed indicated it intended to stick to a low interest rate environment until the end of 2014 and pledged to buy US$40bn of MBS debt every month until the unemployment rate drops significantly below the 8.1% it stands at now.

Nonetheless, there is a sense that investment-grade corporate names that want to come to market should do so sooner rather than later. Bankers speak of printing debt before the crowding dissipates and investors start to look at higher-yielding names. But with no expectations that 10-year US Treasury yields will hit 200bp until early next year, there is still some time.

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