Healthy New Corporate Bond Issuance in a Holiday-Shortened Week
Volatility in the secondary corporate bond market remained low and corporate bond credit spreads hardly budged.
Even as the Memorial Day weekend kicked off the summer slowdown, a number of issuers tapped the new issue corporate bond market. Among the companies we rate, eBay (rating: BBB+, stable) priced a $2.5 billion multitranche transaction with maturities ranging from 3 to 10 years right out of the gates Tuesday. Although summer may have unofficially begun, there was no shortage of demand as the order book for this transaction was reportedly more than 4 times the size of the offering.
Midweek, Goldman Sachs (rating: BBB+, stable) priced a transaction consisting of benchmark-size tranches of 6-year fixed- and floating-rate and 11-year fixed-rate senior unsecured notes. Reportedly, each tranche is callable one year before maturity. We understand this structure to be beneficial to the issuer's ability to manage its liability structure and comply with various regulatory requirements, including its total loss-absorbing capacity and net stable funding ratio. Later in the week, Disney (rating: A+, positive) priced a $2 billion transaction consisting of 3- and 10-year tranches. This was Disney's second issuance in the past three months, following a 5-year note issuance in March. We expect the primary use of proceeds of the proposed notes will be to refinance current debt maturities.
The largest transaction last week was priced by Cardinal Health (rating: A/UR-), which issued a $5.2 billion multitranche transaction in order to help fund part of the $6.1 billion acquisition of Medtronic's patient care, deep vein thrombosis, and nutritional insufficiency businesses as well as redeem Cardinal's 1.70% notes coming due in 2018. Our A credit rating on Cardinal Health was placed under review negative in April after the company announced its plans to acquire these businesses. The planned acquisition of the Medtronic businesses is a large one for Cardinal, and related financing activities look set to initially push gross leverage up to the mid-2s, by our estimates on a pro forma basis, once the acquisition is completed this fall.
Although there was a healthy amount of new issue activity for a holiday-shortened week, volatility in the secondary corporate bond market remained low and corporate bond credit spreads hardly budged. The markets have grown increasingly numb to the rancor and political rhetoric emanating from Washington. The average spread of the Morningstar Corporate Bond Index (our proxy for the investment-grade bond market) widened 1 basis point to + 117, and the BofA Merrill Lynch High Yield Master Index widened only 2 basis points to +369.
Year to date, the Morningstar Corporate Bond Index has tightened 10 basis points; its current level is significantly tighter than its long-term average of 167 bps. Since January 2000, the average spread of the index has only been tighter than the current level 25% of the time. Similarly, the BofA Merrill Lynch High Yield Master Index has tightened 52 bps year to date and is 240 bps tighter than its long-term average of 609 bps. Since January 2000, the index has registered a lower spread only 15% of the time.
Between low interest rates and tight corporate credit spreads, the yields on corporate bond indexes have dropped toward their historical lows. Currently, the average yield of the Morningstar Corporate Bond Index is 3.10%, and the average yield of the BofA Merrill Lynch High Yield Master Index is 5.53%. The lowest yield the Morningstar Corporate Bond Index has registered is 2.52% in May 2013, and the lowest yield the BofA Merrill Lynch High Yield Master Index has registered is 5.15% in June 2014. At that time, the yield on the 10-year Treasury bond was 50 basis points lower than its current level.
As a result of the aforementioned tightening corporate credit spreads and declining interest rates, returns year to date for corporate bonds are running well ahead of the amount that yield carry alone would have produced. Through June 2, the Morningstar Corporate Bond Index has risen 4.43%, and the BofA Merrill Lynch High Yield Master Index has risen 5.03%.
Although credit spreads in the high-yield space were essentially unchanged last week, institutional investors returned to the asset class as high-yield exchange-traded funds saw an inflow of $1.1 billion, which was only minimally mitigated by a small redemption out of the high-yield open-end mutual funds. Year to date, fund flows in the high-yield sector remain decidedly negative and have registered a total outflow of $6.3 billion. After incorporating these redemptions to the annual run rate, over the past 52 weeks, the total amount of net inflows in the high-yield sector is only $3.2 billion.
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