US bond market buckles after surge

(This is an article from the March 20 edition of the International Financing Review, a Thomson Reuters publication)

By Danielle Robinson

NEW YORK, March 23 (IFR) - The glut of high-grade bond supply in the US dollar market finally took its toll in the past week, as the market staggered under the weight of more than US$235bn in deals since the beginning of February.

Only three weeks ago Actavis (NYSE: ACT - news) attracted more than US$90bn of orders for a US$21bn deal priced with just 2bp of new issue concession, but Germany's Merck (LSE: 0O14.L - news) last week struggled to get 1.5 times order book coverage for a US$4bn acquisition financing, even though it left as much as 17bp on the table.

Names such as APT Pipelines and RenaissanceRe failed to price deals tighter than initial price thoughts; Washington Prime Group was forced to drop a 10-year tranche; and utility ONEOK (NYSE: OKE - news) had to widen guidance by 100bp to get its deal done.

Even Citigroup discovered that just 2bp of price tightening can result in almost a third of an order book disappearing. Orders for its US$1bn 10-year subordinated issue slumped from US$2.25bn to US$1.6bn when it squeezed pricing to 193bp from guidance of 195bp.

"Two back-to-back US$50bn-plus weeks in new issuance will cause periods of indigestion and that is what we saw playing out this week," said Jonathan Fine, head of investment-grade debt syndicate at Goldman Sachs (NYSE: GS-PB - news) .

Investment grade bond issuance is up 14% this year at US$328.7bn, versus US$288.193bn in the same period last year, according to IFR data. Of that, more than US$235bn has come in the past seven weeks alone.

Adding to the rout is a renewed slump in oil prices causing volatility in risk assets, and while dovish comments by the Federal Reserve last Wednesday brightened the mood, a rally in Treasury rates as a result will only keep the pressure on borrowers to offer investors more yield in the form of credit spread.

Deal performance has also been hampered by dealers downsizing inventories, which have ballooned in recent weeks.

"A large number of deals that have priced this month are trading wide of new issue as there is a lack of secondary demand for them," said Anne Daley, managing director in investment-grade debt syndicate at Barclays (LSE: BARC.L - news) . "This is in part because investors know there is more to come."

PATIENCE IS A VIRTUE

Bankers are advising borrowers to be patient and wait it out if they can.

"I don't think there has been any shift in the view of credit as an asset class or concern about valuations," said Andrew Karp, co-head of Americas investment-grade capital markets at Bank of America Merrill Lynch. "It is just a matter of the market finding a new equilibrium in supply and demand."

But there are at least two more US$3bn-$4bn-plus bond issues in the pipeline, say market participants, one of which could land in the next week or two.

Reynolds American (NYSE: RAI - news) is still to come to market to put in permanent financing for an acquisition of Lorillard (NYSE: LO - news) , valued at US$25bn. Some believe that up to US$9bn of bonds could be issued.

Meanwhile, Halliburton (Hanover: HAL.HA - news) is expected to seek US$9bn-$10bn of debt to help pay for its acquisition of Baker Hughes, and Imperial Tobacco (LSE: IMT.L - news) is also on the list as a possible issuer of bonds to help pay for its acquisition of US cigarette brands from Reynolds.

High-yield looks more attractive than investment-grade at this point, according to Michael Collins, a senior investment officer and portfolio manager at Prudential (HKSE: 2378.HK - news) .

Although total returns for both markets year-to-date are about the same, at 2.24% for investment grade and 2.08% for high yield according to Barclays indices, Collins prefers to grab the higher yield in junk bonds.

"We are concerned about the fact that the high-grade market has struggled to digest the huge supply we've seen so far this month and some of the recent deals have not performed that well," he said. "Moreover, event risk and credit risk, in general, are increasing."

That said, Collins expects spreads in both high yield and investment grade to tighten.

"I think spreads are likely to tighten over the course of the year as investors in the US come to the realization that low yields are here to stay and that US corporate bonds offer good relative value," he said. (Reporting by Danielle Robinson; Editing by Matthew Davies)