REMEMBER THE DAYS when issuance from US agencies was booming and their calendars dominated the primary markets? The excitement created by a brand name corporate announcing plans for a benchmark issue? Well those days are back – for now at least. Easily understood, corporate credit is now the order of the day, an understandable outcome of so many investors having had their fingers badly burnt on US sub-prime asset-backed securitizations and mezzanine tranches of sub-prime ABS CDOs.
So there is something of a backlash against some of the trends of recent years when nearly all the banks went looking for fixed-income alchemy, seduced by highly quantitative techniques and the associated high fees. As the market’s recent woes show, many structured transactions are so complicated that even the brightest people struggle to understand them. And that is a problem for efficient functioning markets, where transparency is everything. Participants are asking how is it possible to price accurately a security that is based on thousands of non-trading components.
Jim Probert, global head of investment-grade debt syndicate at Bank of America, admits that compared with some parts of the finance world investment-grade bonds might not appear to be very sexy but as he says: "This year we will price possibly $1 trillion of high-grade bonds in the US. Think about it: that is in the midst of the worst credit crunch to have taken place in seven or eight years. It’s an amazing event."
This is a remarkable turnaround because ever since the tech bubble burst in 2001, the plain vanilla bond market has been just that – plain. That period was an exciting time as various borrowers printed multi-billion dollar transactions to finance various investments and acquisitions – since then bond issuance has been rather more mundane. It was an unmistakeable fact that the sexiest, high-margin business took place elsewhere and involved deals based on either lots of leverage or complex structuring, and frequently both.
The summer’s tale of dislocation in money, structured finance and leveraged loan markets needs no retelling here. What is remarkable is how the traditional debt business returned to centre stage with gusto – despite the volatility that financial markets have undergone. In the darkest days of the money market dislocation, the US bond market bore witness to a series of well-known corporate and financial names printing large long-dated bonds. It is amazing how the sudden change in environment, and wider spreads, prompted the return of the largest US real-money investors to credit. These US investors are moving out of treasuries and mortgages and into credit. It’s the first significant asset reallocation shift for five years. And those investors suddenly found themselves able to dictate the terms of price for the first time in many years. Volumes boomed as issuers grabbed as much liquidity as they could.
"The new issue market did what it was supposed to do. We are just turning out new issues at a record pace for this time of year," says Paul Tregidgo, vice-chairman, debt capital markets, at Credit Suisse. "The depth of the crisis was a vivid reminder to the issuing community of the value of term bond market financing."
According to data from Thomson, US targeted dollar bond issuance averaged just under $100 billion for each of the months of August and September, compared with a paltry $33 billion sold in July. A series of rare or significant borrowers were quick to issue paper. Non-A1/P1 borrowers took aggressive action to term out debt and draw down on their liquidity facilities. It was paradoxical that while various triple B rated corporates were unable to raise money in the CP market, nor could they borrow two- or three-year money, they were able to raise 30-year bonds in size. The biggest real-money investors, which were previously underweight credit, were happy to buy corporates and financial names but they demanded duration in return; if they were going to provide liquidity they wanted to be compensated properly.
Contrarian investor
"We were buying new issues at a time when no one wanted to buy them. We tend to be the contrarians and put on risk when no one else wants to. And we tend to take risk off when everyone wants to take risk," says Mark Kiesel, executive vice-president, portfolio manager at Pimco.
He adds: "We basically wait for the blood on the streets then when we feel that we are getting paid to take the risk we’ll come in with pretty good size... A lot of times we can dictate terms."
Bankers say that a handful of investors – no more than 10 – drove the market during August when there were real signs of stress. Thus Wal-Mart was able to refinance short-dated commercial paper debt via $2.75 billion of 10-year and 30-year bonds and reopen the corporate market at the height of the volatility. Johnson & Johnson sold $2.6 billion in the same period. This was the company’s largest new issue and the first in four years. Again the offering sought to replace CP funding with long-term debt. Another notable trade was Kraft Foods’ first bond since the company’s spin-off from Altria. Kraft sold $3.5 billion-worth of bonds spread across three-year fixed and floating tranches, and five-, 10-, and 30-year fixed-rate notes. First-time issuers included Starbucks, which raised $550 million. Meanwhile, AT&T sold $2 billion of 30-year bonds. Investment banks quickly followed suit and raised money at levels that they would never imagined necessary a couple of months earlier – at the worst spreads in five years.
"When banks and brokers needed money this summer, they wanted to send a signal to the marketplace that they had liquidity. In order to do that they needed size and lead orders. Pimco was that lead order," says Kiesel.
Back to basics
Landmark transactions such as these were far from rare in recent months. And it was not just the names that turned up but also the way the market went back to basics that was highly notable. Old-style syndication techniques were necessary because of the negative backdrop. Investors were sounded out before a bond’s announcement – it was understandable that borrowers wanted to minimize execution risk. The prevalence of sole-led transactions increased as banks provided hard underwriting facilities for their clients.