Borrowers warned: Don't be fooled by high grade market resilience

By Danielle Robinson

NEW YORK, May 11 (IFR) - Apple (NasdaqGS: AAPL - news) , Shell (LSE: RDSB.L - news) and AbbVie (Xetra: 4AB.DE - news) blitzed the US bond market last week with a combined US$34bn of jumbo bond deals in just two days, bringing the week's tally to US$52bn, the fourth-largest of all time.

AbbVie issued US$16.7bn to finance its acquisition of Pharmacyclics - it was the sixth-biggest bond deal ever - after attracting US$60bn of demand.

The next day Apple issued US$8bn on US$21bn of demand and Shell US$10bn on US$23bn of orders.

But bankers are warning borrowers planning to raise some US$80bn or more in May not to be dazzled by the US market's seeming resilience.

New (KOSDAQ: 160550.KQ - news) -issue concessions have bulged in the past week after wild swings in 10 and 30-year Treasuries and huge supply took their toll. Now (NYSE: DNOW - news) there are fears that the bond market has reached a tipping point, and corporates may face rising funding costs from here on.

"The real risk to the market over the course of a busy May for new issues is extreme volatility in Treasuries," said Jonny Fine, head of investment-grade debt syndicate in the Americas at Goldman Sachs (NYSE: GS-PB - news) .

"We have gone from new-issue concessions of zero to 5bp in March to a weaker environment where NICs are 10bp-15bp. In the same period credit spreads have widened a little and Treasuries have increased a lot, so all-in costs of debt issuance have deteriorated."

The new-issue market has been able to recover from temporary gluts at various times this year. And, in the absence of Treasury volatility, it only took a few slow weeks to bring concessions snapping back in.

Now, although investors still have cash to put to work, not knowing where rates are heading requires higher concessions, especially at the long end of the curve.

It was no coincidence, then, that Apple paid 10bp in NICs and Shell 11bp-16bp on the day the 30-year Treasury yield pierced the 3% mark for the first time since December.

FUNDAMENTAL

With European government bonds backing up dramatically, commodity prices stabilising and US economic growth expected to improve, some think the Treasury market is undergoing a fundamental shift away from curve flattening, towards a period of steepening at the long end.

"Many former entrenched trends are now over and the new long-term trends have begun," said William O'Donnell, head of US Treasury strategy at Royal Bank of Scotland (LSE: RBS.L - news) .

"We are going through the earliest phase of a 'term-risk tantrum'. What we have witnessed since the end of March is markets coming to grips with ongoing improvement in the US economy and maybe a nascent recovery out of Europe at a time when we are staring at record low European and US yields. It's making people have a complete re-think."

Fed Chair Janet Yellen also made comments during the week that bolstered that view.

"She sent a signal to the market that stocks have gone too high and bond yields are too low at a time when the Fed could raise rates in September," said O'Donnell.

Although yields tightened on Thursday, the wild swings saw issuers such as Anglo American (LSE: AAL.L - news) pay new-issue premiums of as much as 19bp and most other borrowers that day paid double-digit concessions across maturities.

ILLIQUID

Matters will be made worse by the illiquidity in the secondary market.

"Larger new-issue premiums impact future bond pricing to a greater extent than we have seen in the past, due to the illiquidity in the secondary market," said Michael Shapiro, manager on Societe Generale (Paris: FR0000130809 - news) 's US bond syndicate.

"The existing secondary curve can widen because of a larger new-issue premium and the result is wider pricing points when an issuer or one of its peers seeks to return to the market."

Borrowers are also likely to find that they can no longer determine what they will pay in the bond market based on what others are achieving.

"There have been times when the concessions that various credits in different sectors paid have been uniform, but this is not one of those environments," said Fine.

"It's more critical than at any other time for syndicate managers to really understand the difference between individual credits and sectors and how they are likely to be accepted by the bond market versus others."

Strong order books, however, have shown that demand is still there. And bankers and issuers hope that any reduction of demand for bonds from retail investors (put off by the damage done by wider Treasury yields to total returns) will be offset by insurance companies and pension funds coming in for higher-yielding paper.

(This story originally appeared in International Financing Review, a Thomson Reuters publication) (Reporting by Danielle Robinson; Editing by Matthew Davies)