Full Speed Ahead For Auto Bonds

Despite bad news all around, auto makers are tapping the market with no trouble. Here's how.
Ed ZwirnJanuary 19, 2001

Times may be tough in the auto industry.

But that apparently hasn’t hindered Detroit’s finest in tapping the bond market.

In the second major auto bond issue to hit the market in as many weeks, the finance arm of Ford Motor, Ford Motor Credit Corp., announced Thursday that it would be hitting the road next week in the United States and Europe to peddle an offering of at least $5 billion of new debt.

The offering, managed by Deutsche Bank, Goldman Sachs, and Morgan Stanley Dean Witter, will consist of several tranches and be transacted in several currencies.

Interestingly, the news of the bond offering came to light the same day that the auto company released figures showing that fourth quarter profits fell 32 percent because of declining sales.

And, as recently as Jan. 10, DaimlerChrysler reported that its industrial net cash reserves ran out in the fourth quarter of 2000. But the next day, it was in the market with the largest corporate bond offering since December’s record $10 billion British Telecommunications issue.

The international auto giant sold $4 billion of dollar-denominated five-, 10- and 30-year debt, as well as approximately $3.1 billion in euros and sterling.

Did the bad news hurt DaimlerChrysler? Well, hardly.

Reports emanating from underwriters Deutsche Bank, J.P. Morgan Chase and Salomon Smith Barney indicated that the dollar segments of the deal were about four times oversubscribed, while there were about twice as many euros and pounds chasing the other tranches as there were bonds available.

Even allowing for the usual bluster and exaggeration coming from trading desks, the reports are extraordinary, as they are the largest reported over-subscription of a major deal in at least a year.

What Went Right?

True, bond markets in general have been rallying as of late, particularly since the Fed issued its surprise 50-basis point easing announcement on Jan. 3. Corporate bond issuance so far this year has constituted the largest borrowing spree ever by U.S. corporations.

And, far from weakening the market, all this new supply has coincided with a period that has seen corporate debt modestly outperform Treasuries, a reversal of the past several months which had seen spreads widening consistently, hitting record levels.

And while the past couple of weeks has seen all different sectors of U.S. capital markets, including even junk and IPOs, spring back to life, there is still enough volatility in the background to derail offerings which are hit by bad news in their firm or economic sector.

Citing both the slowdown in the economy and in its own orders, Genuity cancelled a $2 billion bond offer on Jan. 16, and the company said it needed time to “complete its assessment of the current slowdown in economic activity and IT spending.”

The move came shortly before the bonds were to have priced and a week after the firm released a report stating that its carrier and Internet Service Provider (ISP) orders declined 44 percent in the fourth quarter of 2000 versus the prior quarter. Click here for more on this topic.

On the other hand, the auto industry offerings have what you could call the “bad news is good news scenario” going for them. Just as in December’s BT deal and other telecom offerings, the investing public was lured by the troubles of the firm and made to perceive the deals as opportunities to purchase debt of the troubled firms on the cheap.

This perception has proven accurate, at least over the short haul.

The recent DaimlerChrysler deal saw most of its segments tighten by around 10 basis points in relation to Treasuries shortly after pricing. The dollar-denominated five-year tranche, which priced to yield 7.323 percent, or 250 basis points over the five-year Treasury Jan. 11., was indicated at around 240 basis points over the five-year as of the morning of Jan. 19, while its yield was around 7.24 percent.

With an improvement like this, it is likely that the FMCC deal will be the beneficiary of the good results obtained by DaimlerChrysler investors.

Part Of Long-Term Strategy

In addition, the auto companies’ strategy of coming in with huge offerings and spreading them out among as many geographical markets seems to be paying off. This is why you see such underwriters of international repute as Deutsche Bank and Morgan Stanley Dean Witter involved.

The allocation between different maturities and currencies gives the issuers flexibility to adjust their offering even hours ahead of pricing to suit demand.

This is in fact a logical outcome of the strategy announced by Ford in June 1999, with the introduction of its so-called GlobLS (“Global Landmark Securities”), the heading under which these new bonds will appear.

Ford, at that point, was seeking to emulate the tremendous success of the Fannie Mae Benchmark and Freddie Mac Reference Notes programs initiated in 1998.

When the two government sponsored enterprises unveiled these borrowing programs at that time, they were given their names with the stated intention of becoming a “benchmark” or “reference” against which future debt could be priced, given the fact that the supply of Treasuries was shrinking. Click here for more on this.

Not only have these programs helped the two GSEs attract massive investor interest, they have greatly increased the GSEs’ leverage versus their underwriters, saving as much as 20 basis points in transaction costs for a typical deal.

But in the “good old” days before the massive run up of Federal debt, it was not uncommon for corporate bond issuers to price their debt relative to other large liquid corporate bonds such as those issued by the financing arms of auto companies.

Until now, Ford’s attempt to bring back these good old days has been the victim of bad timing. Several GlobLS offerings were cancelled at the last minute in 2000, either due to market turbulence or reports of exploding tires on the Ford Explorer.