In a yield-starved world, U.S.-dollar denominated assets look increasingly attractive. Outside the United States, approximately $14 trillion in debt carries a negative yield, which accounts for approximately 46% of the Bloomberg Barclays Global Aggregate Ex-US Index (as of 9/18/2019). Furthermore, the yield-to-worst on the Bloomberg Barclays Corporate Index touched 2.77% in early September, which was only 20 basis points (bps) off the all-time low! A more accommodative Fed, combined with lower U.S. Treasury yields and an improved tone to trade rhetoric, have contributed to a further easing of financial conditions.
Markets began to price in more accommodative Fed policy late in the second quarter and financial conditions eased significantly. These dynamics have led to spread compression of BB-rated corporate bonds relative to the BBB-rated investment-grade cohort. This gap recently touched a new cycle low and remains within 15 bps of the pre-Global Financial Crisis nadir in the low 50s. Additionally, the option-adjusted spread (OAS) of the ICE
BofAML U.S. Corporate Index (126 bps as of 8/30/2019) is near its five-year average. Looking back over the longer term (since 1/31/1997), current spreads are near the 40th percentile. When factoring in adjustments for price, quality, and duration, we would characterize current valuations as more rich than fair.
While these dynamics inform our more conservative, defensive position in corporate bonds, it does present unique opportunities for corporate issuers. In fact, during just the past few weeks, there have been three examples of companies that capitalized on this environment to manage their liabilities with sizeable refinancing deals—two opportunistically from a position of strength and one in an attempt to preserve investment grade ratings while implementing a restructuring. If this rate-spread environment persists, we would expect to see more of this type of activity, as over 50% of corporate debt scheduled to mature during 2020 and 2021 carries a coupon above 3%. From both an issuer and investor perspective, these actions represent prudent capital allocation policies that are net-debt neutral and either improve financial flexibility or reduce financing costs.
Duration, as well as the proportion of the index composed of BBB issuers, is near 20-plus year maximums.
ICE BofAML U.S. Corporate Index – Select Characteristics (1/31/1997 – 8/30/2019)
Source: ICE BAML U.S. Corporate Index
Recent Market Activity
Simon Property Group is the largest publicly-traded retail real estate investment trust in the world, as measured by market value. The company maintains significant financial flexibility and its credit profile is strong.
Simon recently issued $3.5 billion in debt, with tenors of five, 10, and 30 years to finance a cash tender offer for outstanding bonds maturing between 2020 and 2022. The new offerings carried a weighted average coupon of only 2.60%, which was over 100 bps lower than the coupon on the refinanced debt. In effect, the company was able to opportunistically refinance the majority of its near-term debt maturities and place debt with an average maturity profile of 16 years, extending its overall debt maturity schedule by approximately three years.
The Walt Disney Company is a diversified worldwide media and entertainment company. Disney’s strong credit profile is supported by its diverse business segments (e.g., media networks, theme parks, direct-to-consumer, etc.), strong brands, and robust free cash flow generation.
Disney advantageously tapped the market in early September, issuing $7 billion in debt across the curve, with an average coupon of 2.20% and a weighted average maturity of 13 years. The majority of proceeds were used to refinance debt issued through an exchange in conjunction with the 21st Century Fox America acquisition. In addition to repaying its revolver (with a rate tied to 3-month LIBOR), Disney targeted approximately $2.4 billion in term debt with an average coupon of over 6%.
Kraft Heinz Foods Company is the fourth-largest food and beverage company in the world. Over the last several years, Kraft has engaged in increased merger and acquisition activity, leading to higher balance sheet leverage as well as margin deterioration. Poor earnings performance over the last 12 months combined with a Securities and Exchange Commission investigation of accounting practices have resulted in ratings pressure on the company’s low-BBB credit profile.
On September 12, Kraft announced a new $3 billion bond offering with maturities of 10 years and greater. Simultaneously, it announced a cash tender for up to $1 billion of outstanding bonds maturing between 2022 and 2025. Just the prior week, Kraft tendered for $900 million of debt maturing in 2020. The weighted average coupon on the new debt was 4.4%, which was similar to that of the tendered notes. However, the company was able to extend the average maturity profile of the debt through the tender by over 15 years. This will allow Kraft greater financial flexibility to implement a restructuring and help support management’s stated commitment to investment grade ratings.
The Bloomberg Barclays Global Aggregate Index is a measure of global investment grade debt from 24 local currency markets. This multi-currency benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers.
The Bloomberg Barclays U.S. Corporate Bond Index is an unmanaged market-value-weighted index of investment-grade corporate fixed-rate debt issues with maturities of one year or more.
The Goldman Sachs U.S. Financial Conditions Index is a weighted sum of riskless interest rates, the exchange rate, equity valuations, and credit spreads, with weights that correspond to the direct impact of each variable on GDP.
The ICE BofAML U.S. Corporate Index tracks the performance of US dollar denominated investment grade corporate debt publicly issued in the US domestic market.
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