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Monday, 23 October 2017

The party's not over

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  • US dollar and Yankee issuance. Timeline: January — September 27

In contrast with the middling performance of the European debt capital markets, the US bond market continues to thrive. Yankee and domestic issuers are tapping into the highly liquid US investor base and taking advantage of the attractive interest rates, while issuers are enjoying funding near historical lows and continue to push out their maturities. Borrowers see no immediate prospect of an end to the party. Timothy Sifert reports.

The US investment grade corporate bond market has been the go-to place for investors and issuers for the past few years, managing to thrive despite – and because of – the recession, attracting new and seasoned issuers around the globe. But now that the recession and credit crisis are months in the past, and the risk of inflation is perceived by many to be minimal, high-grade bonds are still the security of choice. They are, if nothing else, a higher-yielding safe haven away from nearly riskless Treasuries.

Volumes have tapered off only slightly in the past three years. Issuers that were hit hard by the recession have sought to deleverage and refinance rather than embark on raising new expansionary capital in the face of few growth prospects.

In the first three quarters of this year there were 596 deals, totalling about US$535bn. During the same period in 2009, 581 deals accounted for US$557bn in volume, according to Thomson Reuters SDC data. The year before issuers recorded 617 deals for US$576bn. There are few signs that there is an end in sight to the pace and volume.

“We’re in a period of historically low fixed-rate cost of capital due to low Treasury yields and ever tighter spreads,” said Jim Probert, managing director, head of Americas investment grade capital markets at Bank of America Merrill Lynch. “Investment grade bonds have emerged as a very popular asset class: the amount of money coming out of equity and other funds and into bond funds has been exceptional in 2010.”

Foreign affairs

A prevailing theme all year has been the mounting presence of Yankee issuers. In the year up to September 27 about US$240bn worth of Yankee investment grade bonds have priced, a significant improvement on the past two years. In 2009 only about US$200bn printed, and the year before, the figure topped out at about US$140bn, according to Thomson Reuters SDC.

The driving forces are well known. Conditions were ripe in the US for most high-grade issuers because of low interest rates and the fact that the US had emerged from the depths of the credit crisis before Europe. The European credit markets were in the doldrums for much of this year, while the price for swapping dollars raised in the bond market for euros has been historically attractive. There have been few reasons for foreign issuers to look for capital at home.  

That may change as the European credit markets begin to convalesce. As the international debt markets improve, some of the intended US-dollar volume might go elsewhere.   

“You have to ask, ‘What does the euro market do?’” a high-grade capital markets banker in the US asked. “If it gets substantially better – and it has already improved – that market could see some business that otherwise would have been done in dollars.” 

Thus far, however, Yankee deals, particularly from banks, are still a looming presence. At the end of the third quarter Santander, Nordea, HSBC and National Australia Bank all printed deals in the US market.

Coupon capers

Volumes wouldn’t be so high if coupons weren’t so low. In the second half of the year, issuers were breaking coupon records almost every week. Microsoft’s US$4.75bn four-tranche trade in September seemed to be the high-point of this trend. It was only the issuer’s second trip to the investment grade bond market, and it managed to break two coupons records, tie one and only fall slight short on a fourth.  

Investors, too, are watching coupons, spreads and Treasury prices. “Returns [in this market] have less to do with credit quality and more to do with Treasury prices,” said Jamie Guenther, head of US institutional credit at DP Advisors.

The market has been awash with big corporations that are also ambitions players in the capital markets. IBM set a record in August with a 1.00% coupon on a three-year note, and Microsoft bested the rate with a 0.875% coupon (the same margin Freddie Mac paid for a three-year benchmark reference note in August).

Northern States Power Minnesota, a unit of Xcel Energy, printed a five-year note with a 1.95% coupon, also in August. Microsoft came back with a 1.625% five-year tranche.

In the 10-year category, however, Microsoft took second place with a 3.00% note, behind Johnson & Johnson’s 2.95% coupon from earlier this year. At the long end, Microsoft’s 30-year tied with J&J, San Diego Gas & Electric and Southern California Edison at 4.50%. There was no shortage of historical lows.

Bankers and investors don’t expect low coupons to be a thing of the past, however. At its last meeting, the FOMC expressed concern that inflation was too low for comfort and indicated that it might begin a second round of quantitative easing. That would, in effect, keep Treasury yields down, as well as coupons on corporate bonds.

Potential bond issuers need little more incentive than that to refinance. The only roadblock to continued heavy issuance is supply: now that so many issuers have refinanced out a few years, there is less of a pressing need to come to market, no matter how great the technical advantages.

“There’s been a lot of refinancing and pre-financing,” BofA’s Probert said. “The big question everyone is asking is how much this reduces supply in 2011?”

This way to M&A?

It is difficult to predict the volumes for the fourth quarter and next year, in part because this year’s brisk market allowed issuers to push out their maturities beyond 2011. But the perennial question mark is M&A-driven business: when will transaction-backed bond offerings return?

“M&A is always the wildcard,” a banker said.

Anecdotally, there is more reason for hope. High-grade issuers are beginning to make and seek acquisitions. On September 27 Southwest Airlines agreed to buy AirTran Holdings in a cash-and-stock transaction worth about US$3.4bn. Southwest was last in the bond market in December 2008.

On the same day, Wal-Mart announced that it wanted to buy South Africa’s Massmart Holdings for about US$4.5bn in cash. Also, BHP Billiton is engaged in a US$39bn hostile bid to acquire Potash Corp.

On top of that, there have been well-performing M&A-related deals at the end of the third quarter. Investors have already had a taste.

On September 27, NBC Universal (Baa2/BBB+) hit the market with a US$5.1bn transaction to fund one of the more creative merger transactions of the past few years, its combination with Comcast and eventual separation from General Electric. The media conglomerate hit the market with a 144A/Reg S offering comprising four tranches: 3.5s, 5.5s, 10.5s and 30.5s. Demand was well spread out among the tranches and the book drew about US$12bn worth of support.

Proceeds will be used to prefund a cash distribution to General Electric, a condition of the joint venture between NBC and Comcast. The bond agreement includes mandatory redemption at 101 if the JV does not close by June 10 2011. This is the second time this year NBC tapped the bond market to pay for the Comcast combination. On April 27 it printed a US$4bn three-part trade. 

On the same day, Exelon Generation, rated A3/BBB/BBB+, printed a US$900m offering of 10s and 31s to fund the purchase of John Deere Renewables, a wind power operator and developer. New issue concessions on both tranches were around 15bp. The book was split US$1bn to the 10s and US$800m to the 31s.

Nonetheless, M&A-related trades take some time to materialise. “The fourth quarter will probably be slower than the third,” said BofA’s Probert. “But there could be more strategic deals. For example, if a corporation feels pressure from shareholders they could engage in share repurchases.”

“There are so many companies that have cash overseas and want to return it,” a banker said. One solution is illustrated by Microsoft, which plans to use its bond proceeds for general corporate purposes, including share repurchases. Like many conservative corporations, Microsoft has a lot of cash on its balance sheet – about US$40bn – but much of it is inaccessible because it is held at foreign subsidiaries. Microsoft tapped the bond market to get the cash it needed to give back to shareholders, as well as other US dollar denominated costs.

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