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Credit Insights

New Issue Corporate Bond Market Springs to Life Before Summer Slowdown

Issuers were looking to complete new issue debt offerings before the beginning of summer.

Through Thursday, the average spread of the Morningstar Corporate Bond Index (our proxy for the investment-grade bond market) was unchanged from the prior week at +118. In the high-yield market, the Bank of America Merrill Lynch High Yield Master Index tightened 11 basis points to +367. Year to date, credit spreads in the investment-grade space have tightened 10 basis points and high-yield credit spreads have tightened 54 basis points. At their current levels, corporate credit spreads are much tighter than their long-term averages of +167 and +608, respectively. From a long-term perspective, the average spread of the Morningstar Corporate Bond Index has been lower than the current level less than one fourth of the time since the end of 1999. Since the end of 1999, the average spread of the high-yield index has only been tighter 17% of the time. However, neither index is close to historic lows. For example, the tightest spread our investment-grade index registered was +80 in February 2007. The tightest spread the high-yield index registered was +241 in June 2007.

After a relatively quiet prior week, the new issue corporate bond market sprang back to life last week as numerous corporations priced transactions ahead of the Memorial Day weekend. As typically happens, issuers were looking to complete new issue debt offerings before the beginning of summer. With many investment bankers and portfolio managers taking vacations, the new issue capital markets often slow in the summer months as fewer market participants are available and then picks back up again after Labor Day. Many of the transactions priced last week were conducted to support impending mergers and acquisitions. For example, Becton, Dickinson and Co (rating: BBB+/UR-) raised almost $10 billion worth of debt to help fund part of the $24 billion acquisition of C.R. Bard Inc (rating: A+/UR-). This transaction is being financed through a combination of new borrowings, equity issuance, and existing cash. We placed our credit ratings for Becton and C.R. Bard under review with negative implications as we expect this acquisition will increase debt leverage yet again, less than three years after Becton's leverage-increasing CareFusion acquisition. Since then, Becton has actively deleveraged by repaying debt and increasing profits; as of March, debt/EBITDA has reached the company's target of about 3 times. By issuing another $10 billion of new debt to acquire Bard, Becton's management team estimates leverage will rise to 4.7 times when the transaction closes. Although the firm plans to reduce leverage to below 3.0 times within a few years of this deal, we think this leverage-increasing transaction may weaken its Cash Flow Cushion and Distance to Default pillars enough to consider a downgrade. Tyson Foods Inc. (rating: BBB-, positive) issued $2.75 billion of notes in a multitranche offering consisting of both fixed- and floating-rate notes. Proceeds from the notes are expected to finance the acquisition of AdvancePierre. Earlier this month, Morningstar Credit Ratings, LLC affirmed Tyson's credit rating at BBB- and assigned a positive outlook.

Although credit spreads in the high-yield space tightened and asset volatility subsided, investors withdrew $1.4 billion of funds from the high-yield asset class last week. The redemptions occurred across exchange-traded funds as well as open-end funds. Among the high-yield open-end mutual funds, redemptions were slightly over $1.0 billion; in the high-yield ETF sector, outflows were $370 million. Year to date, fund flows in the high-yield sector remain decidedly negative, with a total outflow of $7.3 billion. After incorporating these redemptions into the annual run rate, over the past 52 weeks, the total amount of net inflows in the high-yield sector is only $2.2 billion.

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