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Credit Insights

New Issue Supply Weighs on Investment-Grade Market While High Yield Ekes Out Slight Gain

They failed to follow the lead of the equity market, which hit new highs.

A heavy new issue calendar weighed on the corporate bond market last week. Even though economic metrics point to continued economic expansion and earnings season winds down without too many negative surprises, the corporate bond market failed to follow the lead of the equity market, which hit new highs. In the investment-grade market, the average credit spread of the Morningstar Corporate Bond Index (our proxy for the investment-grade corporate bond market) widened 2 basis points to end the week at +115. The high-yield market, which is typically more closely correlated to the equity market, was able to eke out a slight gain as the average spread of the ICE BofAML High Yield Master II Index tightened 4 basis points to +372. As an indication of how much the new issue supply weighed on the market, several issuers had to pay 10- to 20-basis-point concessions from existing trading levels in order to complete their offerings. Other issuers were able to sell their bonds at tighter concessions but were unable to tighten pricing to the lower end of their price guidance.

However, while credit spreads have traded within a tight range recently, both investment-grade and high-yield bonds have performed extremely well thus far this year. Year to date, the average spread in the investment-grade market has tightened 42 basis points and in the high-yield market has tightened 161 basis points. The tightening among credit spreads and decrease in underlying interest rates have driven the investment-grade index 5.52% higher and the high-yield index 8.90%.

While "green bonds" have been more commonly issued in the European markets, bond issuers are increasingly making use of green bonds in the United States. For example, Starbucks tapped the markets last week and issued $1 billion of 10-year notes and $1 billion of 30-year bonds. The 30-year bonds were denoted as green bonds as the proceeds were earmarked to be used for sustainable and social projects. According to the International Capital Market Association, "Green bonds enable capital-raising and investment for new and existing projects with environmental benefits." To be considered a green bond, the issuer commits to using the proceeds from the bond issue for projects that will enhance its climate or environmental profile. Currently, there are no governmental regulations that stipulate what a company must do to designate a bond issue as a green bond, but the ICMA has published Green Bond Principles 2018, which outlines its voluntary process guidelines for issuing green bonds. Typically, the issuer will solicit a second-party opinion to provide investors with an assessment as to the firm's adherence to the ICMA's four core components of the Green Bond Principles. In this case, the green bond opinion was provided by Sustainalytics, which can be found here. There was strong investor demand for the offering, with reportedly $6 billion of orders for the $2 billion offering.

Investors will continue to have a lot to choose from this week. According to Bloomberg, new issue supply in the corporate bond market may reach $35 billion-$40 billion. The expected supply includes a potential $20 billion offering from Bristol-Myers Squibb (AA-/UR-). We had placed our credit rating under review with negative implications following the announcement in January of a formal offer to merge with Celgene Corp (A-/UR+), which we also placed under review, albeit with positive implications. Bristol-Myers Squibb expects to close the roughly $74 billion transaction in the third quarter and fund the purchase with equity funding of $38 billion, available cash, and $32 billion in incremental debt. After the deal is completed, we estimate that gross leverage will stand around 3 times at the combined entity, about 2 turns higher than Bristol's stand-alone leverage but similar to Celgene's stand-alone leverage.

Corporate Bond Spreads Trading at Tightest Historical Quartile
After approaching their long-term averages at the end of last year, the snapback thus far this year has brought credit spreads back to some of the tightest levels they have traded at over time. Since the beginning of 2000, the average spread of the Morningstar Corporate Bond Index is 162 basis points. At the current level of 115, the index is trading 47 basis points tighter than its long-term average. To put this in context, the index has only ever traded at a tighter level about 27% of the time.

In the high-yield market, credit spreads are even tighter compared with their historical averages. Since the beginning of 2000, the average spread of the ICE BofAML High Yield Master II Bond Index is 586 basis points. At the current level of 372, the index is trading 214 basis points tighter than its long-term average. The index has only ever traded at a tighter level about 20% of the time.

Weekly High-Yield Fund Flows
After a slight withdrawal the prior week, investors returned to the high-yield market last week. Total inflows across high-yield open-end mutual funds and exchange-traded funds were $0.9 billion last week. Inflows were concentrated among open-end mutual funds, which received $0.8 billion of the inflows as net unit creation among high-yield ETFs was only $0.1 billion.

Year to date, total inflows into the high-yield asset class is $16.4 billion, consisting of $9.0 billion of net unit creation among high-yield exchange-traded funds and $7.4 billion of inflows across high-yield open-end mutual funds. However, the amount of inflows year to date have still not been enough to offset the amount of outflows this asset class suffered during the fourth quarter of 2018. Over the past 52 weeks, total outflows equal $2.6 billion, of which the outflows were driven by $6.1 billion of withdrawals across open-end mutual funds, as ETFs outflows have recuperated and more and have seen a total of $3.4 billion in new unit creation.

Morningstar Credit Ratings, LLC is a credit rating agency registered with the Securities and Exchange Commission as a nationally recognized statistical rating organization ("NRSRO"). Under its NRSRO registration, Morningstar Credit Ratings issues credit ratings on financial institutions (e.g., banks), corporate issuers, and asset-backed securities. While Morningstar Credit Ratings issues credit ratings on insurance companies, those ratings are not issued under its NRSRO registration. All Morningstar credit ratings and related analysis contained herein are solely statements of opinion and not statements of fact or recommendations to purchase, hold, or sell any securities or make any other investment decisions. Morningstar credit ratings and related analysis should not be considered without an understanding and review of our methodologies, disclaimers, disclosures, and other important information found at https://ratingagency.morningstar.com.