Bond Concessions Reach Most Since January: Credit Markets
Borrowers are offering the biggest concessions since the start of the year to sell new corporate bonds in the U.S. as Europe’s sovereign-debt turmoil intensifies and signs emerge that America’s economy is weakening.
Investment-grade companies paid an average of 21 basis points more in relative yields in the two weeks ended June 1 than investors accepted for their outstanding bonds with similar maturities, according to Barclays Plc data. The level, the highest since reaching 26 basis points in the week ended Jan. 6, has soared from this year’s low of negative 4 in February.
Even with cash on corporate balance sheets at about record highs, investors are demanding more compensation as speculation grows that Greece may exit the 17-country euro area and U.S. employers add the fewest workers in a year. The number of credit rating downgrades in the U.S. this year exceeds upgrades at Moody’s Investors Service, reversing the trend a year earlier.
“We are in uncharted waters and investors want to be compensated for that type of uncertainty,” Kevin Flanagan, chief fixed-income strategist for Morgan Stanley Smith Barney, said in a telephone interview from Purchase, New York. Europe’s debt upheaval “has been elevated in terms of concerns and anxieties. If the situation in Europe were to deteriorate even further, obviously spread levels would widen, and as an investor you probably would be demanding more of a concession,” he said.
United Technologies Corp. (UTX), the maker of Sikorsky helicopters and Pratt & Whitney engines, offered a 68 basis- point concession on $2.3 billion of 10-year bonds it sold on May 24, according to data compiled by Bloomberg and Trace, the bond- price reporting system of the Financial Industry Regulatory Authority. Northfield, Illinois-based Kraft Foods Inc. (KFT)’s $6 billion offering on May 30 included $2 billion of 3.5 percent, 10-year notes at a spread of 200 basis points, or 75 more than where its bonds due February 2020 were quoted.
Company bond offerings worldwide fell behind the pace set in 2011 last month with issuance of $1.69 trillion in the first five months of the year compared with $1.76 trillion in the same period last year, Bloomberg data show. As recently as the end of April, offerings were ahead of last year and the first quarter of 2012 was a record for the period.
Elsewhere in credit markets, the cost of protecting corporate bonds from default in the U.S. declined for a second day, with the Markit CDX North America Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, declining by 4.1 basis points to a mid-price of 121.7 basis points as of 11:52 a.m. in New York, according to prices compiled by Bloomberg.
The index, which has declined from a five-month high on June 4, typically falls as investor confidence improves and rises as it deteriorates. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
The U.S. two-year interest-rate swap spread, a measure of bond market stress, declined 2.9 basis points to 32.75 basis points as of 11:55 a.m. in New York. That’s the lowest level on an intra-day basis since May 11 for the gauge, which narrows when investors favor assets such as corporate bonds and widens when they seek the perceived safety of government securities.
Bonds of Petroleos de Venezuela SA are the most actively traded dollar-denominated corporate securities by dealers today, with 81 trades of $1 million or more as of 11:56 a.m. in New York, Trace data show.
Deere & Co. sold $2.25 billion of bonds yesterday, including $1 billion of 10-year, 2.6 percent notes that pay a relative yield of 105 basis points, or a concession of 5 basis points over where its $500 million of 2.75 percent bonds due March 2022 were trading on June 4, Trace data show.
As concern that Europe’s debt crisis is spreading has mounted, the average concession that investment-grade corporate bond issuers in the U.S. are making to sell new debt has climbed 17 basis points since the week ended May 4, Barclays data show.
The shift is occurring as investors seeking safer assets have pushed the benchmark 10-year Treasury note yield to a record low of about 1.44 percent on June 1.
“Given the rate rally, the new issue concession is a way for investors to capture yield they can’t get in the secondary market,” Justin D’Ercole, head of investment grade syndicate for the Americas at Barclays in New York, said in a telephone interview. “It has, in a way, become the only game in town for investors that are yield-oriented. Why buy 10-year paper in the secondary market at 2.75 percent when you can get 3 percent buying primary?”
Investors bid for four times the amount of deals on offer in the week ended June 1, an increase from 2.4 when concessions last peaked at similar levels on Jan. 6, according to Barclays.
Relative yields at 233 basis points are the widest since Jan. 24, according to the Bank of America Merrill Lynch U.S. Corporate Master index. Investors have pushed up yields on the debt to 3.47 percent from the 3.33 percent record low reached on May 8, the index shows.
Concessions are still below the 12-month peak of 43 basis points reached Oct. 7, according to Barclays.
“There isn’t the same urgency to the situation, or the same tail risk in front of us, as last fall” before the European Central Bank stabilized markets by offering loans to the region’s lenders, D’Ercole said.
Greece has at least a one-in-three chance of leaving the 17-country euro area within months of a June 17 election that could halt its international bailout, S&P said June 4 in a statement. It’s uncertain how so-called core members of the currency union would respond, creating a risk of debt restructuring in other countries and downward pressure on ratings, the company said.
In the U.S., employers added the smallest number of jobs in a year in May, stoking concern the economic recovery is faltering. Payrolls increased by 69,000, below median estimates of 150,000, while the jobless rate rose to 8.2 percent, according to Labor Department figures released June 1.
When you combine Europe “with some of the economic numbers, underscored by the employment report on Friday, when you’re looking to put money to work in the corporate arena, there probably needs to be a concession due to the uncertain situation,” Flanagan said.
U.S. companies’ cash reserves are at about the highest on record. The ratio of cash to total assets for companies in the S&P 500 Index stood at about 9.86 percent yesterday after reaching a record 10.3 percent in September, Bloomberg data show. The ratio has risen from 5.6 percent in April 2007.
At the same time, leverage is increasing and yields for speculative-grade borrowers at 8.35 percent as of yesterday, compared with a five-year average of 10.42 percent, according to the Bank of America Merrill Lynch U.S. High Yield Master II index. Yields reached a record low 7.19 percent in May 2011.
“Total debt growth has accelerated, in part as higher quality companies look to lock in near record low yields,” Morgan Stanley analysts led by Adam Richmond wrote in a June 1 research report. Leverage for U.S. high-yield companies reached 3.72 times in the first quarter, compared to 3.67 times in the previous period.
Moody’s has tallied 206 downgrades of long-term debt this year in the U.S. compared with 195 upgrades, Bloomberg data show. In the same period last year, the ratings firm had 156 downgrades versus 210 upgrades.
Hartford, Connecticut-based United Technologies’ 3.1 percent, 10-year bonds yielded 135 basis points more than similar-maturity Treasuries, Bloomberg data show. The spread compares with its existing $1.25 billion of 4.5 percent securities due April 2020 that were quoted at 66.8 basis points before the new deal priced, Trace data show.
The 3.1 percent notes traded at a spread of 103.2 basis points yesterday, Trace data show.
Maureen Fitzgerald, a spokeswoman for United Technologies, declined to comment.
The $2 billion of 3.5 percent, 10-year notes from Kraft’s grocery spinoff were issued at a relative yield of 200 basis points compared with the spread of 125 basis points on the company’s existing $3.75 billion of 5.375 percent bonds due February 2020 before the new deal priced, Trace data show.
Michael Mitchell, a Kraft spokesman, said executives weren’t immediately available for comment.
“Market conditions have been weakening of late,” Edward Marrinan, macro credit strategist at Royal Bank of Scotland Plc in Stamford, Connecticut, said in a telephone interview. “For deals to get a strong reception from investors, underwriters and issuers have had to offer larger concessions.”
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