Banking & Capital Markets

Yield Hogs Hit the Feeding Trough

Issuers taking advantage of lower rates and strong demand.
Ed ZwirnFebruary 5, 2001

Different segments of the Great American Fundraising Machine continue to react differently to the same set of facts.

Treasuries and investment-grade debt are being snapped up quicker than they are being printed, with the result being a classic win- win scenario for both issuers and investors.

The bottom line: Not only are Treasury yields shrinking, investment-grade paper is outperforming Treasuries, making them look better to investors because of decreased spreads, and to issuers, because absolute yields are plummeting.

Indeed, investment-grade paper, which is at its lowest yield level since about May 1999, outperformed Treasuries by about 10 basis points through Thursday, when trading levels started to back up due to the large supply ($12.5 billion) of investment-grade debt priced through that point.

Further jitters were inspired by Friday morning’s employment report. Despite the “headline” number showing January unemployment up to 4.2 percent, most markets remain fixated on the reported increase of 268,000 in payrolls for the period. Click here for report.

“The data don’t argue strongly for an intra- meeting Fed rate cut,” says a report by Standard & Poor’s MMS.

But even after the backup, investment-grade bonds had tightened by about eight basis points on the week in general.

Going into more speculative territory, the outlook is–not surprisingly–more tentative. The value of high-yield issues in the pipeline is about $1 billion, way off from levels seen a week or two ago, and trading levels, while described as “firm,” are not seeing the same improvement as in the higher grades.

Meanwhile, initial offerings of common stock have yet to pump up the volume since the beginning of the year, as many had hoped.

Yield Hogs Weigh In

But despite the seeming inconsistency, there is an overriding logic at work.

With most experts agreeing that interest rates will likely continue to decline in the foreseeable future and the threat of inflation will remain nonexistent, the fixed-income crowd is charging straight ahead, offering issuers a good opportunity to lock in lower- than-anticipated rates.

Propelling the charge is the desire among investors to lock in as wide a “spread” as possible over Treasuries for as long a period of time as possible.

“Non-callable vehicles with spread, such as agencies and [investment-grade] corporates have been tightening even in the face of the Fed moves,” a market source notes. “It’s a case of bond buyers being yield hogs.”

Go Long!

As a result, issuers have been playing up to these yield hogs by issuing more paper than they had intended. This suddenly revived seller’s market has also made it easier for less speculative corporations to borrow using long-term securities.

Last week’s Treasury refunding announcement (which said there would be no more one-year bills in the future) also set off a new round of speculation as to the future of 30-year government paper.

The 30-year fever heated up Wednesday, after the Treasury Advisory Committee of the Bond Market Association published a report saying that most of its members believed “that if the budget outlook does not change, elimination of long-dated issuance is inevitable at some point.”

“A majority felt that there was sufficient evidence to justify elimination in the near future,” the report said. Click here for report.

This, plus reports that PIMCO fund manager Bill Gross, probably the world’s largest bond investor, was looking into 30-year corporates, set off a mini-flood of new corporate long bonds on Thursday by investment-grade issuers seeking to take advantage of conservative investors seeking longer duration.

Archer-Daniels Midland, Norfolk Southern, and Westvaco Corp. rushed a total of $1.4 billion of new 30-year issues to market on that date. Significantly, all three issues contained make- whole call provisions as a hedge against a change in the interest-rate environment.

This means the issuer can call the bond and in return hand over to the borrower the entire principal plus a sweetener of about 20 to 25 basis points, depending upon the issue.

The other “hot” investment-grade sector continues to be finance paper, particularly auto finance, which greatly exceeded the gains posted for investment grade as a whole, tightening by about 30 basis points last week. The finance sector is definitely back after getting beaten up over the last couple of months,” says one trader at a New York syndicate desk.

Witness the reception given Ford Motor Credit Co.’s $1 billion addition to the $3 billion five-year issue it priced on Jan. 25: The new bonds hit the market at 172 basis points over the five-year Treasury, versus the Jan. 25 pricing level of 200 over treasuries.

Pipeline Still Full

Looking ahead, it is not surprising, given the robust atmosphere in the sector, that investment-grade bond offerings will continue at close to full speed in the week ahead.

Highlights include:

  • AES Corp., a global energy corporation, which has announced plans to issue $600 million of 10-year bonds this week.
  • Hilton Hotels, which plans $300 million of Baa3/BBB- rated 10-year notes via Morgan Stanley Dean Witter and Banc of America Securities.
  • Vulcan Materials, a producer of crushed stone, gravel and sand for construction projects, plans $200 million of five-year notes via Goldman Sachs. The debt is rated A1 by Moody’s Investors Service and single-A-plus by S&P.

As far as junk is concerned, Merrill Lynch Director Katheryn Okashima says that while “the market’s opening up a little, the financing window has not opened up” enough to include the more risky credits.

Among the issuers include AEA Investors and DLJ Merchant Banking Partners, which plan $275 million of high-yield bonds along with $775 million of higher-yielding loans via Deutsche Bank and Credit Suisse First Boston. The money will be used to partly finance their buyout of BF Goodrich Performance Materials, B.F. Goodrich Co.’s chemical business.

Other issuers said to be hitting the market soon include Tenger Paper, Ono and Memec, according to Okashima.

IPOs also seem to be picking up steam, although their level of issuance through the coming week will still be well below that of the peak seen in the earlier part of last year.

Those hoping for a return to the blockbuster deals of yore were certainly disappointed last week, when word leaked out that Taiwanese Telephone, which had been planning a deal said to be worth more than $3 billion via UBS Warburg, has given up on issuing this year.

“[The IPO market has] generally started to improve,” says Michelle Petropoulos of Williams Capital Group. “But the larger deals are not going to get done right now.”

That said, one long-range high-profile deal to which the market can look forward is Verizon Wireless. The entity, which is 55 percent owned by Verizon, “will successfully complete a partial IPO around mid-year, replacing short- term debt that will be incurred by Verizon and loaned to Verizon Wireless to fund Verizon Wireless’ recent purchases of spectrum and assets,” according to Moody’s.

This week will see the volume nonetheless pump up a bit.

On Monday, ATP Oil & Gas Exploration plans 7.5 million shares via Lehman Brothers, CIBC and Dain Bosworth, at a range of $15 to $18; California Pizza Kitchen plans 3.4 million shares at $28.25; Ciena plans eight million shares via Goldman Sachs, Morgan Stanley Dean Witter and Banc of America Securities.

Others expected in the market later in the week include Oil States International, OMP, Vectran, and Williams Energy Partners.

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