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Saturday, 21 October 2017

Very versatile

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The US high-grade bond market rebounded quickly this year, proving much more receptive to borrowers’ needs than loans or other more structured asset classes. Bonds have been used to term out bridge loans, refinance strong issuers’ balance sheets and, most notably, fund acquisitions directly. With such a financing resource at their disposal, issuers are bolder than ever. Timothy Sifert reports.

The US high-grade bond market came full circle in 2009.

Several large, high-profile trades in the first half were driven by M&A volume, notably Pfizer and Roche, two pristine credits. They funded their purchases with bonds while that market was hot – and the loan market was anything but. Both record-breaking offerings – US$16.5bn from Roche and US$13.5bn from Pfizer – priced before the purchases they backed were completed.

That in itself was an anomaly in the credit markets: acquirers usually obtain loans to fund a deal’s cash portion, before tapping the bond market to term out the bridge once the merger is finalised. But desperate times called for drastic measures: Pfizer replaced its bridge loan commitment with bonds before its deal was funded, saving a lot of money; Roche didn’t even bother arranging a loan at all.

All sizeable bridges were eventually termed out, and an emerging equity bull market, alongside other factors, soon made large acquisitions almost impossible. Throughout the resulting downturn in M&A activity the bond market stayed strong. Issuers continued to come to market, but now for different reasons – for example balance sheet repair.

Some infrequent and first-time issuers even exploited the capital-raising opportunity when they didn’t need the cash. Take Microsoft’s US$3.75bn offering in May, the first bond for the tech giant. Investors and analysts had been urging Microsoft to rearrange its pure equity capital structure for years. Taking heed, the company saw the spring-time market as the ideal moment, assembling a US$15bn order book, with all three tranches pricing at around 100bp over Treasuries. Most impressively, the five-year notes came at plus 95bp. Before that, no industrial credit had beaten the 100bp barrier since 2007.

More recently, M&A activity has picked up again, and the bond market is expected to benefit once more. On September 28, Abbott announced it would acquire the Solvay Group’s pharmaceutical products business for €4.5bn or US$6.6bn in cash.

On the same day, Xerox said it will buy Affiliated Computer Services in a cash and stock deal worth about US$6.4bn. JP Morgan agreed to provide a US$3bn one-year bridge to bond to fund the deal and repay ACS debt. ACS shareholders get US$18.60 in cash per share plus 4.935 Xerox shares for each ACS share they own, the cash portion totalling US$1.886bn. Xerox will also assume US$2bn of ACS debt and issue US$300m in convertible preferred stock to ACS’s class B shareholder. The deal will close in Q1 2010.

The bridge agreement gives Xerox an incentive to repay the loan quickly – or to circumvent the loan market altogether in favour of more slimly priced bonds. Timing is important, according to the fees and spreads: the bridge carries a duration fee of 75bp 90 days after the acquisition closes, 150bp 180 days after, and 225bp 270 days after; the Libor spread is potentially even more damning, with a margin ranging from plus 250bp in the first three months after closing date, at current ratings, to plus 875bp 33 months after closing, at speculative ratings.

The receptivity bond market is another stimulus for M&A. Kraft is pursuing a US$16.7bn debt-financed merger with Cadbury, despite Cadbury’s rejection of the offer. Kraft’s persistence is fuelled by the availability of debt. "We have strong banking relationships and good access to the debt capital markets and feel quite confident that we will not have difficulty with financing," said Tim McLevish, Kraft’s CFO, during the September conference call to European analysts.

If the deal is completed at the offer price, Kraft would need a roughly US$8bn bridge. Cadbury’s swift rejection of the offer had analysts anticipating an increased cash portion from Kraft, in which case the bridge financing could reach US$11bn.

Walt Disney’s US$4bn cash and stock acquisition of Marvel Entertainment, Baker Hughes’ purchase of BJ Services for US$5.5bn in cash and stock and other deals are set to keep the market busy.

"Recently, bonds have been used primarily for balance sheet repair - bond tenders and refinancing," said Jim Merli, managing director, head of US fixed income syndicate at Barclays Capital. "M&A had been absent, but that is starting to change."

Financial issuer flee

Corporate issuers found pockets of demand this year partly because of the absence of FIG issuers. Guaranteed bank-issued debt, which comprises most of this year’s FIG issuance, resembles agency bonds more than corporate bonds, and goes to a different investor base.

Investors that usually stocked up on quality financial new issuers could or would not buy low-yielding Triple A paper being sold under the Temporary Liquidity Guarantee Program. So they turned to industrial names.

In the first three quarters of this year there were 567 straight corporate deals, totalling US$545.82bn. In the same period of 2007, volume reached US$783.426bn. That is quite a difference. But in 2007 FIGs were issuing straight bonds en masse without government help, and were counted among the corporate debt totals. This year banks across the globe used government-backed programmes to issue more than US$300bn in debt in the US. That is not counted in the corporate investment grade volume. Non-FIG issuance drove the market this year.

"The bond market this year has gone from one extreme to the other,” said Barclays’ Merli. “What was a fairly dislocated market just a few months ago is now a robust, active one. Gradually the market has improved across the credit spectrum and has broadened to include deals of size, with short and long maturities.”

Investment grade financial issuers, largely responsible for last year’s turmoil, were among the first issuers to tap the US high-grade bond market this year – albeit with government support. Now that the TLGP is expiring, FIG issuers are making a stronger appearance in the straight corporate debt market. It is a welcome return.

Goldman Sachs, JP Morgan, Bank of America and Morgan Stanley, among others, have all issued unguaranteed debt, with a lot of success. And the market keeps on getting better: Morgan Stanley printed a US$3bn 5.625% 10-year on September 16 at plus 225bp. Compare that to the A2/A/A rated bank’s US$2bn 7.30% 10-year on May 8, which priced to yield plus 400bp.

Many issuers are noticing the positive signs from the bond market. "It didn't happen over night," Merli said of the turn-around. "The OAS in the credit index was in the mid 500s in December and it currently around 190. Spreads were at all time historical wides for some issuers, and now they're at historical tights."

Making history

US investment-grade investors are welcoming issuers of every stripe. Deals price tightly throughout the credit spectrum in a variety of industries, indicating issuers might be able to take care of much of their 2010 refinancing ahead of schedule. Not surprisingly, companies are breaking their own financing records.

The week of September 14 was one of the busiest of the year, with volumes breaching the US$30bn mark. Shell International Finance (Aa1/AA/AA+) demonstrated what a quality credit can do, printing two tightly priced fixed and floating two-year bonds, when corporate investors had shunned two-year floaters, in particular, all year. That investors are warming to the floating-rate part of market indicates optimism. Shell's offer started to circulate as a 2/6/10 fixed issue but the addition of the two-year floater brought the total to US$5bn.

Offered originally as a three-part – at about US$1bn per tranche – Shell's deal was whispered at plus 40bp, 90bp, and 90bp–95bp, respectively. That led to guidance of plus 40bp area, plus 90bp–95bp and plus 90bp–95bp.

The US$500m two-year floater was added and priced at three-month Libor plus 3bp.

The US$1.5bn two-year 1.30% fixed-rate tranche was priced to yield 37.5bp; the US$1bn 3.25% six-year came at plus 90bp; and the US$2bn 4.30% 10-year came at plus 90bp as well. That looked to be about flat to outstanding notes, and the book was around US$10bn.

Shell's two-year fixed tranche now holds the record for the lowest coupon in history. At 1.30% it beats Procter & Gamble's 1.35% rate on its two-year notes due August 26 2011, which were priced on August 25.

Investors have not been unduly picky, dignifying some lower quality Triple B credits as well. The harsh realities of the housing sector did not stop Toll Brothers Finance (Ba1/BBB–BBB–) from tapping the investment-grade market in the same week as Shell. The homebuilder made the rounds with a US$250m 10-year offering, whispered at 7.00%–7.125%, with guidance tightening 6.875% area due to early support. The deal eventually priced to yield 6.75%, which was flat to outstanding notes.

The second half of the year has seen the US bond market in relentless mood. "September is going to end up being one of the busiest months of the year," Merli said. "While September is typically a strong month, what's different this year is that we didn't experience much of a slowdown in July and August. That is pretty amazing."

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