When Bank of America came up with the concept behind the Core Investment Grade Bond Trust several months ago, it probably seemed an excellent idea. The environment was after all one where many investors were hellbent on decreasing exposure to the largest and most volatile individual corporate names. So what could be better than an aggregate product that offered them lower transaction costs, a diverse pool of bonds with an average A3/A- rating and the promise of secondary market price-making support from the arranging banks?
Unlike similar aggregate bonds such as Morgan Stanley’s Tracers and Lehman Brother’s Trains, Core also offered issuers the chance to raise new money through a potentially large and liquid transaction. This was attractive, since many frequent issuers were seeing spreads widen and were loath to offer stand-alone bonds into a volatile market.
Unfortunately, by the time Core was launched last month it had failed to meet the expectations of either constituent. Bank of America and JPMorgan, which BofA brought in as joint bookrunner, had hoped to launch one jumbo $4 billion to $8 billion bond. But investor demand on that scale wasn’t there and the A3/A- rated deal was launched at just $2.025 billion, despite being a global rather than 144A issue, like Tracers, which should have widened its appeal.
For the 22 issuers that sold bonds into the Core trust, the product didn’t offer enough funds – many went back to the market directly the next week with their own issues. One banker says: “It’s an interesting idea and if they had raised $5 billion to $8 billion, I would have said it was a good deal, but at just $2 billion it wasn’t what investors wanted and was just a marketing exercise. It is not difficult to find five-year demand off MTN programmes at $100 million for 20 issuers. You could do this in the afternoon.”
This is a big oversimplification of a complex deal. The timing was certainly unlucky. The $2.025 billion raised was bigger than anything else that had come out over the summer. For this in itself, Core should be given credit. Analysts say an aggregate spread product like this is great for putting short-term funds to work when primary supply and secondary market liquidity is scarce. Unfortunately Core was priced on a Friday before a week when the primary issuance floodgates opened and $20 billion-worth of high-grade corporate bonds came to the dollar market.
Bank of America and JPMorgan declined to comment on the transaction because of SEC regulations, but Louise Purtle, senior US analyst at CreditSights, says it was launched too late to take advantage of the bearish investor sentiment that had typified the market through the summer. “Core just happened to come at a time when the market was beginning to look more optimistic about corporates. So credit managers may disparage the benefits of a product which just gives them exposure to the spread market without really allowing them to overlay their credit analysis on it.”
Admittedly, Core was partly responsible for the market’s revival. General Mills, Occidental Petroleum and CarrAmericaRealty all launched $350 million, $175 million and $175 million five-year deals respectively through Bank of America and JPMorgan after Core hit the market with identical coupon payment dates and maturities as their constituent bonds within the structure. A market source says that although these issuers wanted to do more, Bank of America and JPMorgan limited any issuer’s individual weighting to 7.5%. Duke Energy, Dow Chemical and Vodafone, which were also in Core, also came with longer-dated transactions after its launch.
Some investors say Core did not attract more support because, unlike Tracers, it is a passive product, akin to a closed bond fund in that it is not actively managed and any security that drops out of the pool cannot be replaced. Nor can it be increased, decreased or redeemed on investor demand. The other problem was that the pool of issuers, while subsequently popular with investors on a stand-alone basis, wasn’t large or diverse enough, with only one European corporate and a bias towards finance companies. Nor do they replicate the indices many credit managers are obliged to track.
And though selling new five-year MTNs – rather than taking portions of existing benchmark bonds into a pool, as Tracers and Trains have done – offers advantages to investors in that all the coupon and principal repayment dates are identical and issuers pay arranging fees, there can be downsides. These arise if any of these securities are booted out of the pool in case of a default, a rating downgrade below Baa3/BBB- or if one of the issuers ceases to file with the SEC. This structure may mean the rest of the Core transaction can continue to trade without a massively wide bid-offer spread, but it increases the possibility that investors will be left with illiquid MTNs with no trading history outside the trust.
Launching an aggregate structure with new primary issuance was a further hindrance to achieving the targeted size, according to one banker, who says getting 22 issuers and all the investors to agree on a particular spread to launch $2 billion of five-year bonds simultaneously “would be a logistical nightmare”.
That each issuer’s weighting in the deal had to be relatively similar also hindered the size. Although some bankers question whether even the $2 billion was fully sold, another source says the deal was actually over 20% oversubscribed but it could not be upsized in chunks of less than $25 million per issuer.
The deal’s initial secondary market performance has been good, though, tightening over 10bp from 167bp over treasuries at launch.
