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Corporate Bond Frenzy Despite Fundamentals


Senior Market Analyst at Interactive Brokers

A tsunami of new investment-grade corporate bond sales has flooded the U.S. primary market, amid ever-present, ultra-low interest rates, as well as central bank support for the economy and financial system.

High grade corporate issuers continue to swarm the docket, adding nearly US$14bn worth of debt Tuesday to a growing mountain of deals, while demand among bond investors remains squarely intact.

Indeed, bond buyers – especially those who have been priced out of their local markets or have a dearth of available paper – appear to express unrelenting interest for the yield offered in new U.S. dollar-denominated corporate debt, despite credit concerns and recent lackluster returns.

Corporate bond issuance surges in 2020 YTD YoY

Among the deals that priced Tuesday, for example, triple-‘B’ rated, nuclear electric power company Exelon Generation (NASDAQ: EXC) saw orders for its 5-year senior note issuance soar before upsizing it to US$900m from US$550m, initially.

Mischler Financial, which served as an active co-manager on the offering, observed that the final order book finished at a “notably substantial” US$2.65bn, a bid-to-cover rate of nearly 3.0x,  while spreads compressed 42.5 bps over the course of pricing – from initial price talk of +337.5 bps to guidance of +295 bps, where it launched and priced.

Ron Quigley, head of fixed income syndicate at Mischler Financial, noted that while “some accounts took a deeper dive into the credit,” with one expressing some “credit concerns with the increased leverage and natural gas competition, while a bit worried about spin off risk,” the deal “built very quickly to a sizeable order book on a very busy day,” with a total of 14 investment-grade corporate  issuers offering an aggregate of 18 tranches.

He added that the success of the deal, in the context of the competitive landscape, was “in and of itself” an “impressive” feat.

Fundamentals Aside

Meanwhile, ultra-low borrowing costs, along with the Federal Reserve’s recently implemented backstop, have lured other ‘BBB’ issuers to the primary market multiple times, including beleaguered media giant ViacomCBS (NASDAQ: VIAC).

ViacomCBS priced US$2bn worth of 12-year and 30-year bonds Tuesday, with spreads having narrowed by around 30 bps – 35 bps over the course of the offering.

The demand for ViacomCBS-issued debt seems to exemplify the willingness of bond investors to largely rely on the Federal Reserve’s policies, and overall government support for the economy, as many companies in the media industry continue to contend with fundamental damage wrought by the Covid-19 crisis. 

ViacomCBS Stock plunged ~60% YTD Amid Mounting Pressures

Employment in the arts, entertainment, and recreation industry, for instance, plummeted by 1.3m in April, contributing roughly 6% to the mammoth drop of 20.5m total nonfarm payrolls in that month, as well as an historic 14.7% spike in the unemployment rate – the highest in the history of the series dating back to January 1948.

Furthermore, ViacomCBS suffers its own idiosyncratic risks, including uncertainties over ad spending, unease within Paramount’s theatrical film business, as well as the potential for sunken costs in the roll-out of less-than-engaging content.

Moody’s analyst Neil Begley recently noted the company’s credit positioning is also significantly impacted by “the risks surrounding the secular transitional pressure facing linear network television and broadcast stations, and the restructuring of Viacom’s brands.”

He added that the “effects of underinvestment in these brands years ago, combined with current secular cord cutting trends, has resulted in low viewer ratings for many of the company’s individual networks, which has affected both ad revenue and relationships” with multichannel video programming distributors (MVPDs).

Year-to-date in 2020, ViacomCBS has seen its stock plunge by almost 60%, and was last trading at US$17.07 intraday Wednesday, according to the IBKR Trader Workstation.

Undeterred Appetite

However, despite fundamental concerns that plague the credit backdrop, bond investors’ appetite for corporate debt has generally continued unabated.

For the week ending May 6, Refinitiv U.S. Lipper Fund Flows reported net inflows of more than US$6.6bn into investment-grade funds, while high yield funds received roughly US$3.5bn. In the same week, high grade corporate bonds were the worst performing fixed-income asset class, with returns of -1.04%.

Nuveen analysts Bill Martin and John Miller observed that the investment-grade corporate sector was dragged down by “heavy issuance and a longer duration,” which effectively ended the week at 8.25 years.

10-Year U.S Treasury Rates have fallen more than 120 bps YTD

Nuveen noted that spreads widened and “the sector suffered a negative total return, well behind” that of U.S. Treasuries at -0.30%. Likewise, they added, the global aggregate sector experienced a negative total return (-0.79%) and lagged U.S. markets, “as the European region sharply underperformed.”

Since the start of 2020, the yield on the 10-year U.S. Treasury note has plunged by over 120 basis points to trade at around 0.654% intraday Wednesday. However, other 10-year notes from foreign governments appear far more expensive, including a -0.527% yield in Germany, -0.052% in France, and -0.007% in Japan.

Rate Drivers

While many in the market have eyed signals from federal funds futures that the Federal Reserve may cut interest rates into negative territory before the year’s end, investment-grade corporate bond issuance has generally skyrocketed.

High grade corporate bond supply has mushroomed by more than 78% to date in 2020 over the prior year to a little over US$732bn, while high yield debt has risen 23.1% to US$102.2bn over the same period, according to data compiled by the Securities Industry and Financial Markets Association (SIFMA).

In fact, other regions and countries, where central banks have maintained zero or negative interest rate policies since the financial crisis of 2008-09, such as the European Central Bank (ECB) and Sweden’s Riksbank, have also witnessed a material increase in the level of their non-financial corporate credits.

Low. zero, negative central bank rates spur global, non-financial corp levels higher

Recent figures from the Bank for International Settlements show that, since June 2005, non-financial corporate debt in the U.S. has grown at a compound annual growth rate (CAGR) of 4.91% to almost US$16.1tn at the end of 2019, while Germany’s credits have increased at a 2.44% CAGR to US$2.3tn, and Sweden at a 5.82% CAGR to US$906bn over the same period.

The global, lower-rate environment, combined with several variations of quantitative easing, or ‘QE’, measures at certain central banks, including the Fed and the ECB, have also generally spurred investors to assume more risk, as government bonds have risen in price.

However, QE’s effects of flooding the financial system with liquidity have also been blamed by many in the market for inflating asset prices and creating massive debt bubbles

Corporate bond investors will most likely continue eyeing further central bank, and other government stimulus measures to help combat the novel coronavirus-inflicted economic and financial carnage, as well as their related impacts on creditworthiness across sectors, globally.

In the meantime, OAS spreads on U.S. investment-grade corporate bonds narrowed by 1bp in the intraday trading session Tuesday to just north of 203 bps, with the communications sector outperforming at -2.3 bps (+228 bps) on the day.

For more insights, use the global bond scanner in the IBKR Trader Workstation to locate corporate bonds that are available to trade in the secondary market, along with U.S. Treasuries, municipal bonds, non-us sovereign debt and more.

IBKR TWS bond scanner
Disclosure: Interactive Brokers

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The author does not hold any positions in the financial instruments referenced in the materials provided.

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