The investment grade credit market continues to benefit from the euphoria of risk-on sentiment that is flooding the capital markets. The OAS on the index closed Thursday at its tightest level of the year. Segmenting the index out by quality, both the A-rated portion of the index and the BBB-rated portion are now trading at year-to-date tights. The market also feels quite strong as we go to print on Friday morning and it looks likely that the corporate bond index will close the week even tighter still. On the Treasury front, rates are higher across the curve, with the 5yr Treasury up 6 basis points over the past week and the 10yr Treasury up 5 basis points.
Corporate issuance was somewhat muted as borrowers brought just $10.15bln of new debt during the week. Corporate issuance is likely to remain light in the weeks to come as many companies are now in earnings blackout periods. The big story of the week on the new-issuance front was non-corporate borrower Saudi Arabian Oil Co, which priced $12bln of new debt across 5 tranches. The Saudi bonds were soaked up by yield chasers across the globe on no other analysis other than it was “cheap for the rating.” According to Bloomberg, the order book for the new issue was allegedly in excess of $100bln which is quite strong relative to the $12bln size of the deal. However, all 5 tranches of debt immediately traded wider on the break and all remain wider on the bid side as we go to print. The 10yr tranche in particular is sucking wind, and is currently bid at +120 in the street versus its new issue pricing level of +105. This leads us to believe that demand for this deal may have been overstated, possibly by an order of magnitude. $26.2bln of new corporate debt has been priced in the month of April and the year-to-date tally of new issuance is up to $346bln according to data compiled by Bloomberg.
According to Wells Fargo, IG fund flows during the week of April 4-April 10 were +$8.7bln. This brings YTD IG fund flows to +$81bln. 2019 flows to this juncture are up 2.6% relative to 2018.
The performance of investment grade credit during the opening quarter of the year was in stark contrast to the final quarter of 2018, as risk assets of all stripes performed well during the first quarter. The spread on the Bloomberg Barclays US Corporate Index finished the quarter 34 basis points tighter, after opening the year at a spread of 153 and closing the quarter at a spread of 119. The one-way spread performance of investment grade credit was so pronounced that at one point in the quarter there was a 22 trading day streak where the market failed to close wider from the previous day.i This was a remarkable feat considering that there were just 61 trading days during the quarter. The 10yr Treasury opened the year at 2.68% and closed as high as 2.79% on January 18th, but it finished the quarter substantially lower, at 2.41%. Tighter spreads and lower rates yielded strong performance for investment grade credit and the Bloomberg Barclays US Corporate Index posted a total return of +5.14%. This compares to CAM’s gross total return of +4.95% for the Investment Grade Strategy.
What a Difference Three Months Makes
When the Federal Reserve issued its December FOMC statement the consensus takeaway by the investor community was an expectation of two rate hikes in 2019 with one additional rate hike thereafter, in 2020 or 2021. In any case, the prevailing thought was that we were nearing the end of this tightening cycle with a conclusion to occur over the next two or three years. The Fed then took the market by surprise in late January, with language that was more conservative than expected as FOMC commentary signaled that they were less committed to raising the Federal Funds Rate in 2019. It was at this point that the market perception shifted – with most investors expecting just one rate hike in the latter half of 2019. The March FOMC statement was yet another eyeopener for Mr. Market, with language even more dovish than the decidedly dovish expectations. The consensus view is now murkier than ever. Some market prognosticators are pricing in rate cuts as soon as 2019; but the more conservative view is that barring a material pickup in global growth or domestic inflation we may not see another increase in the federal funds rate for 6-12 months, if at all in this cycle. It is entirely possible that the current tightening cycle has reached its conclusion and that lower rates could be here to stay.
In the days following the March 20th FOMC release, the 10yr Treasury rallied sharply and there were two days during the week of March 25th where the 90-day Treasury bill closed with a slightly higher yield than the 10yr Treasury. This was the first time that this portion of the yield curve has been inverted since August of 2007. Note that this inversion was very brief in nature and as we go to print at the end of the day on April 1st, the 3m/10yr spread is no longer inverted and is now positive sloping at +17 basis points. That is not to say that this portion of the curve will not invert again, because Treasury rates and curves are dynamic in nature and ever changing.
What Has Happened to Corporate Credit Curves?
This is a common question in the conversations we have had with our investors in recent weeks. Corporate markets are entirely different from Treasury markets and behave much more rationally. The defining characteristic of corporate credit curves is that they nearly always have a positive slope. History shows that corporate credit curves typically steepen as Treasury curves get flatter. There are fleeting moments from time to time where corporate credit curves become slightly inverted but these instances are brief in nature and are quickly erased as market participants are quick to take advantage of these opportunities. For example, there may be a motivated seller of Apple 2026 bonds at a level that offers slightly more yield than Apple 2027 bonds. This has nothing to do with dislocation in the Apple credit curve and everything to do with the fact that there is an extremely motivated seller of the bond that is slightly shorter in maturity. Once that seller moves their position, the curve will return to normalcy and you could once again expect to obtain more yield for the purchase of the 2027 bond than you would for the 2026 bond. The following graphic illustrates current 5/10yr corporate credit curves for two widely traded investment grade companies, one A-rated and one BBB-rated. As you can see, corporate credit curves are much steeper than the spread between the 5 and 10yr Treasury.
The Bottom Line
The takeaway from this exercise is that investors will always be afforded extra compensation by extending out the corporate credit curve. At Cincinnati Asset Management, one of the key tenets of our Investment Grade Strategy is that we believe that it is nearly impossible to accurately predict the direction of interest rates over long time horizons. However, throughout economic cycles, we have observed that the 5/10 portion of the curve is usually the sweet spot for investors. Consequently, the vast majority of our client portfolios are positioned from 5 to 10 years to maturity. We will occasionally hold some positions that are shorter than 5 years but we almost never purchase securities longer than 10 years. Further, while an investor can earn more compensation for credit risk by extending out to 30yrs, more often than not this strategy entails excessive duration risk relative to the compensation afforded at the 10yr portion of the curve. Our strategy allows us to mitigate interest rate risk through our intermediate positioning and allows us to focus on managing credit risk through close study and fundamental analysis of the individual companies that populate our portfolios.
Where in the World is the Yield?
The value of negative yielding global debt hit a multiyear low in October of 2018 but it has exploded since, topping $10 trillion as the sun set on the first quarter, the highest level since September 2017.ii
The growth in negative yielding debt has, in some cases prompted foreign investors to pile into the U.S. corporate debt market. A measure of overseas buying in 2019 has more than doubled from a year earlier according to Bank of America Corp.iii Japanese institutions are among the biggest of the foreign investors and the Japanese fiscal year started on April 1, which could lead to even more buying interest in U.S. corporates according to Bank of America. According to data compiled by the Federal Reserve as of the end of 2018, Non-U.S. investors held 28% of outstanding U.S. IG corporate bonds.iv What does this all mean for the U.S. corporate bond market? First, it is safe to assume that foreign demand certainly played a role in the spread tightening that the investment grade credit markets have experienced year to date. Second, although U.S. rates may seem low, when viewed through the lens of global markets, they are actually quite attractive on a relative basis. As long as these relationships exist then there will be continued foreign interest in the U.S. credit markets.
Although our Investment Grade Strategy trailed the index in the first quarter, we are pleased with the conservative positioning of our portfolio. The modest underperformance can largely be explained by our significant underweight in lower quality BBB-rated credit relative to the index. We do not have a crystal ball, but are reasonably confident that we are in the later stages of the credit cycle so we continue to place vigilance at the forefront when it comes to risk management. Please know that we take the responsibility of managing your money very seriously and we thank you for your continued interest and support.
This information is intended solely to report on investment strategies identified by Cincinnati Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. Fixed income securities may be sensitive to prevailing interest rates. When rates rise the value generally declines. Past performance is not a guarantee of future results. Gross of advisory fee performance does not reflect the deduction of investment advisory fees. Our advisory fees are disclosed in Form ADV Part 2A. Accounts managed through brokerage firm programs usually will include additional fees. Returns are calculated monthly in U.S. dollars and include reinvestment of dividends and interest. The index is unmanaged and does not take into account fees, expenses, and transaction costs. It is shown for comparative purposes and is based on information generally available to the public from sources believed to be reliable. No representation is made to its accuracy or completeness. See Accompanying Endnotes
i Bloomberg Barclays US Corporate Total Return Value rounded to the nearest hundredth from the close on January 3rd, to the close on February 7th
ii Bloomberg, March 25, 2019, “The $10 Trillion Pool of Negative Debt is Late-Cycle Reckoning”
iii Bloomberg, March 22, 2019, “U.S. Corporate Debt Is on Fire This Year Thanks to Japan”
iv CreditSights, March 8, 2019, “US IG Chart of the Day: Who’s Got the Bonds?”
In the first quarter of 2019, the Bloomberg Barclays US Corporate High Yield Index (“Index”) return was 7.26%, and the CAM High Yield Composite gross total return was 7.22%. The S&P 500 stock index return was 13.65% (including dividends reinvested) for Q1. The 10 year US Treasury rate (“10 year”) spent most of quarter between a range of 2.79% and 2.60%. However, over the last week and a half of the quarter, treasuries rallied and the 10 year yield dropped the range and finished at 2.41%. The 2.41% yield was down 0.28% from the end of the 2018. During the quarter, the Index option adjusted spread (“OAS”) tightened 135 basis points moving from 526 basis points to 391 basis points. This tightening in Q1 was after the massive 210 basis points of widening that took place in Q4 2018. During the first quarter, every quality grouping of the High Yield Market participated in the spread tightening as BB rated securities tightened 119 basis points, B rated securities tightened 144 basis points, and CCC rated securities tightened 187 basis points.
The Finance Companies, Energy, and Utilities sectors were the best performers during the quarter, posting returns of 9.00%, 8.27%, and 7.81%, respectively. On the other hand, Other Financial, Insurance, and Transportation were the worst performing sectors, posting returns of 5.12%, 6.33%, and 6.34%, respectively. At the industry level, refining, oil field services, pharma, and supermarkets all posted the best returns. The refining industry (12.20%) posted the highest return. The lowest performing industries during the quarter were retail REITs, office REITs, airlines, and life insurance. The retail REIT industry (2.86%) posted the lowest return.
During the first quarter, the high yield primary market posted $74.4 billion in issuance. Issuance within Financials was the strongest with almost 18% of the total during the quarter. The 2019 first quarter level of issuance was a bit more than the $66.4 billion posted during the first quarter of 2018. When 2019 is complete, it is likely that the final issuance for the year will be higher than the $186.9 posted during all of 2018. The Federal Reserve held two meetings during Q1 2019, and the Federal Funds Target Rate was held steady at both meetings. While the Target Rate didn’t move, the real story was the shift in messaging by the Fed. The January FOMC statement showed that the Fed was at least thinking about the end of rate increases.i The March FOMC statement moved further in that direction with officials acknowledging weaker economic reports and downgrading their GDP estimates.ii Additionally, the Fed dot plot was signaling zero rate hikes in 2019 as of the March statement. This was down from a projected three hikes in 2019 from just three months ago. The Fed is still currently out of step from what the market is expecting. Even with no hikes projected in 2019, they are projecting one hike in 2020. However, market participants are currently pricing in a better than fifty percent probability that the Fed cuts rates in 2019.
While the Target Rate moves tend to have a more immediate impact on the short end of the yield curve, yields on intermediate Treasuries decreased 28 basis points over the quarter, as the 10-year Treasury yield was at 2.69% on December 31st, and 2.41% at the end of the quarter. The 5-year Treasury decreased 28 basis points over the quarter, moving from 2.51% on December 31st, to 2.23% at the end of the quarter. Intermediate term yields more often reflect GDP and expectations for future economic growth and inflation rather than actions taken by the FOMC to adjust the Target Rate. Inflation as measured by core CPI has been trending lower since the 2.4% print in mid-2018. The most recent print was 2.1% as of the March 12th report. The revised fourth quarter GDP print was 2.2% (quarter over quarter annualized rate). The consensus view of most economists suggests a GDP for 2019 around 2.4% with inflation expectations around 1.9%.
Over the course of Q1, more headlines had been made about certain parts of the yield curve inverting. Importantly, the much watched 2year/10year has yet to invert and at quarter end maintained a spread of 15 basis points. Additionally, some market participants are not as concerned that the yield curve inverts, but they are focused on the magnitude of inversion. There has been work done suggesting that the central bank is compressing the 10 year by around 65 basis points.iii Further, there are other forces at play that have the ability to move rates meaningfully for a period of time. Recently, a wave of traders hedging their positions in the swaps market helped explain the downward move in treasury rates.iv The prolonged government shutdown was a major news item during the quarter. The shutdown lasted 35 days making it the longest shutdown in US history. Ultimately, the shutdown ended with a short term funding package to provide Congress time to negotiate a deal on immigration and border security. As the short term package approached its deadline, legislation was signed to fund the government through September of 2019. Across the pond, the withdrawal of the United Kingdom from the European Union, known as Brexit, continued to dominate the headlines. Many votes have been held in Parliament to decide the Brexit outcome. However, the debate continues and the eventual ripples around the globe are still far from clear. Finally, the trade negotiations between the US and China are ongoing. The very latest reports suggest that representatives are going line by line over the proposed agreement and the end is likely near.
Being a more conservative asset manager, Cincinnati Asset Management remains significantly underweight CCC and lower rated securities. For the first quarter, each quality cohort posted very similar performance. As noted above, our High Yield Composite gross total return was also very similar to the return of the Index. With the market so strong to start the year, our cash position was the largest drag on our overall performance. Additionally, our underweight in the energy sector and overweight in the consumer cyclical services industry were a drag on our performance. Further, our credit selections within the consumer cyclical services industry hurt performance. However, our overweight in the capital goods sector and midstream industry were bright spots. Further, our credit selections within the midstream, other industrial, and building materials industries were a benefit to performance.
The Bloomberg Barclays US Corporate High Yield Index ended the first quarter with a yield of 6.43%. This yield is an average that is barbelled by the CCC rated cohort yielding 10.52% and a BB rated slice yielding 4.85%. Equity volatility, as measured by the Chicago Board Options Exchange Volatility Index (“VIX”), declined throughout the first quarter moving from a reading of 25 down to 14. High Yield default volume stayed low during the first quarter with only nine issuers defaulting. The twelve month default rate was 0.94% and is the lowest default rate since 2014. v Additionally, fundamentals of high yield companies continue to be mostly good. From a technical perspective, supply remains generally low and flows have been positive during the first three months of the year. Due to the historically below average default rates, the higher yields available relative to other spread product, and the diversification benefit in the High Yield Market, it is very much an area of select opportunity that deserves to be represented in many client portfolio allocations.
With the High Yield Market starting 2019 firing on all cylinders in terms of performance, it is important that we exercise discipline and selectivity in our credit choices moving forward. The first quarter displayed similar returns across the quality buckets, and that is unlikely to remain the case over the balance of the year. As the returns start to diverge, it is expected that more opportunities will present themselves. The market needs to be carefully monitored to evaluate that the given compensation for the perceived level of risk remains appropriate on a security by security basis. It is important to focus on credit research and buy bonds of corporations that can withstand economic headwinds and also See Accompanying Endnotes enjoy improved credit metrics in a stable to improving economy. As always, we will continue our search for value and adjust positions as we uncover compelling situations.
This information is intended solely to report on investment strategies identified by Cincinnati Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. Fixed income securities may be sensitive to prevailing interest rates. When rates rise the value generally declines. Past performance is not a guarantee of future results. Gross of advisory fee performance does not reflect the deduction of investment advisory fees. Our advisory fees are disclosed in Form ADV Part 2A. Accounts managed through brokerage firm programs usually will include additional fees. Returns are calculated monthly in U.S. dollars and include reinvestment of dividends and interest.The index is unmanaged and does not take into account fees, expenses, and transaction costs. It is shown for comparative purposes and is based on information generally available to the public from sources believed to be reliable. No representation is made to its accuracy or completeness.
i Bloomberg January 30,2019: “Fed Folds as Message Shifts to Peak from Pause”
ii Bloomberg March 20, 2019: “Powell’s FOMC Turns Pessimistic and Passive”
iii Bloomberg December 19, 2018: “For Some, Curve Inversion Isn’t If or When, But How Deep”
iv Bloomberg March 26, 2019: “Here’s Why Bond Yields Plunged So Much Over the Past Week”
Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were $1.9 billion and year to date flows stand at $15.2 billion. New issuance for the week was $3.8 billion and year to date HY is at $61.8 billion, which is 4% over the same period last year.
(Bloomberg) High Yield Market Highlights
S. junk bonds saw the biggest fund inflow in 10 weeks as the rally extended with yields dropping across the risk spectrum.
Junk bonds have seen cash inflows for four consecutive weeks and in 10 of the last 12 weeks
Retail funds have reported net inflows of ~$15b YTD vs the $19b outflows for the same period in 2018
Yields were near 6-month lows and spreads held firm near the October levels as oil was above $60 and equities rebounded
On Staples’ aggressive $2.125b 2-part offering to fund a dividend distribution to equity sponsors, a secured tranche had orders of more than $2.5b, while the unsecured tranche was about deal size
Staples is out with initial price talk of 10% area for a $1.375b 8-year unsecured tranche and about 7.5% on a $750m 7- year secured bond
Junk bond returns rose to 7.64% YTD making it still the best since 2003
CCCs slid to 7.54% YTD after posting negative returns yesterday
Single-Bs beat CCCs with 7.65%
BBs return is 7.5%
IG returns are 4.78%
Loans have gained 4.54%
The energy sector posted the best 1Q return since 2009 with 8.3% and it continued to be the best performing sector YTD, with 9.32%
Low default, steady oil, a dovish Fed, strong technicals — reflected in net inflows and slow issuance — boost risk assets
(Reuters) UGI to buy rest of AmeriGas Partners in $2.44 billion deal
Energy distributor UGI Corp said on Tuesday it would buy the remaining nearly 75 percent it does not own in retail propane marketer AmeriGas Partners LP in a cash-and-stock deal valued at $2.44 billion.
Pennsylvania-based UGI also cut its fiscal 2019 profit forecast because of a warmer-than-normal winter in Europe
In the AmeriGas deal, shareholders will receive 0.50 shares of UGI in addition to $7.63 in cash for each share owned, the companies said in a statement.
The offer represents a premium of 13.5 percent to AmeriGas’s Monday closing price. The company’s shares were up 13 percent in morning trade on Tuesday.
“This transaction significantly enhances UGI’s free cash flow, one of the key elements of our long-term success,” UGI Chief Executive Officer John L. Walsh said on a conference call with analysts.
“It will allow us to increase our dividend by a cumulative 25 percent,” he added.
(Business Wire) U.S. Department of Energy extends AECOM-led joint venture contract at the Savannah River Site for an additional 18 months
AECOM, a premier, fully integrated global infrastructure firm, announced today that the U.S. Department of Energy’s (DOE’s) Savannah River Operations Office in Aiken, South Carolina, extended the current liquid waste management contract with AECOM-led Savannah River Remediation LLC. The approximate US$750 million extension will run from April 1, 2019, to September 30, 2020. The value of the contract extension was included in AECOM’s backlog in the second quarter of fiscal 2019.
“We are pleased that the DOE has decided to extend Savannah River Remediation’s contract,” said John Vollmer, president of AECOM’s Management Services group. “AECOM has a long history of supporting the DOE at the Savannah River Site and extensive experience in liquid waste disposition. We are committed to safely managing the radioactive waste system at the site while reducing the state of South Carolina’s critical environmental risk.”
During the contract extension period, services that the AECOM-led joint venture will perform are operating the Defense Waste Processing Facility and Saltstone Production Facility, and continuing progress on the Tank Closure Cesium Removal demonstration and construction project and the construction of Saltstone Disposal Unit 7.
(Wall Street Journal) T-Mobile Spells Out CFO Exit Plan
T-Mobile US filed an amended employment agreement for its finance chief that spells out a plan for him to leave the company as it awaits regulatory review of a proposed merger with rival Sprint Corp.
CFO Braxton Carter has been a key figure in the mobile carrier’s pending deal to buy Sprint. A spokeswoman for T-Mobile declined to comment on whether a successor had been chosen.
Carter’s last day at T-Mobile will be decided by the status of the merger, the company said in a regulatory filing with the Securities and Exchange Commission. Mr. Carter is scheduled to leave at one of three fixed dates, depending which arrives first: the end of 2019; 20 days after the first quarterly filing of the merged company; or 20 days after an announcement the deal is off.
Analysts speculated about the departure of Mr. Carter in September, when T-Mobile said Sunit Patel would join the company to lead its expected integration with Sprint. Mr. Patel had been chief financial officer at CenturyLink Inc.
March has priced $19.4b so far, the slowest third month since 2009
Average March issuance has been $31b in last five years
This will be the slowest 1Q since 2016, which was hit by WTI dropping to a more than 13-year low
Inflows slowed a bit this week as markets stalled
Net inflows total ~$11b YTD vs outflows of ~$18b in the same period last year
S. high yield returns of 6.99% YTD is best since 2003
BBs beat single Bs and CCCs with a YTD return of 6.99%
Single-Bs beat CCCs, with YTD return of 6.949%
CCCs YTD was 6.76%, the lowest in the high yield space
CCCs are having best 1Q since 2012
Leveraged loans, higher in the capital structure, have YTD returns of 3.85%
S. junk bonds operate against backdrop of strong technicals as reflected in net inflows into retail funds and light supply, low default rate, steady corporate earnings, Fed accommodation
Markets imply more than a 55% probability of the Fed cutting rates as early as September and 62% in October
(Reuters) Leverage levels peaking again on US mega buyouts
Leverage levels on US private equity buyouts are returning to record levels and private equity firms’ equity checks are shrinking as banks underwrite more aggressive loans, safe in the knowledge that they will not be penalized by regulators.
Average leverage levels of 6.8 times in 2019 so far are rebounding towards a recent record of 6.97 times in the third quarter of 2018, before year-end volatility cooled the market and the number fell to 6.09 times, according to LPC data.
As leverage and the amount of debt that sponsors are piling on businesses is rising, the amount of equity they are contributing is falling. Equity checks of 35.7% in the first quarter of 2019 so far are lower than 38.7% in 2018 and 43.3% in 2017, the data shows.
Huge highly leveraged buyout loans are contributing to the spike, including US$3.2bn of loans for travel commerce platform Travelport and a US$6.4bn dual-currency loan for Power Solutions, which backs the buyout of Johnson Controls’ battery unit.
Current leverage ratios are the highest debt-to-Ebitda levels seen since the second quarter of 2007, before the financial crisis, when leverage also averaged 6.8 times. This is due to regulators giving more freedom to arranging banks and investors’ hunt for higher yield, market participants said.
US regulators implemented Leveraged Lending Guidance (LLG) in 2013 to limit systemic risk. This imposed extra scrutiny on loans with leverage greater than 6 times and also required all secured debt or half of total debt to be able to be paid down within five to seven years.
LLG was relaxed last year when government agencies said that it was guidance and not a rule, which is encouraging banks to arrange more highly leveraged deals without fear of regulatory penalties. It is also producing riskier deals and more aggressive market conditions.
(CNBC) Bond market says not only is a recession coming, but the Fed will cut interest rates to stop it
Fed funds futures were pointing to a quarter point in easing, as traders said scary signals continued to emanate from the bond market
There was an inversion in the yield curve, meaning very short rates rose above longer 10-year note rates, a fairly reliable recession signal
Traders say the bond market may be overreacting, while stocks seem to be ignoring the recession warnings and fears the Fed will have to jump in with one or more rate cuts to stop the economy from rolling over
One strategist commented that he believes some of the moves in the market Monday were more about technical signals and short squeezes than real fear about recession. The Fed changed the tone in markets significantly when it was even more dovish than expected and cut its rate forecast to just one for this year from two.
(Bloomberg) Here’s Why U.S. Bond Yields Plunged So Much Over the Past Week
The Federal Reserve’s surprise policy shift last week shook markets, but, even still, the intensity of the ensuing drop in U.S. bond yields has puzzled many observers. A massive wave of hedging in the swaps market helps explain the scale of the eye-catching move.
Treasuries rallied after the Fed signaled it was done raising interest rates for the moment, driving yields on 10-year notes down to levels last seen in 2017. That forced two sets of
traders — those who had bought mortgage bonds and those who had bet markets would remain calm — to turn to derivatives markets to tweak their portfolios or stanch their losses. They snapped up positions in interest-rate swaps, pushing Treasury yields down even more.
What’s the evidence? While yields on 10-year Treasuries declined to as low as 2.35 percent, the rate on similar maturity swaps dropped to as little as 2.30 percent, according to data compiled by Bloomberg. The 10-year swap spread, as the gap between the two is known, had shown the swap rate at a premium for nearly all of the past year until last week. But that has now flipped to a discount and the gap has gone to a level unseen since 2017, indicating a flurry of activity in the derivatives market.
The Treasuries rally and resulting volatility surge quickly burned those who had sold options, pressuring them to hedge in the swaps market by receiving fixed rates. That’s tantamount to going long Treasuries and is a profitable trade if yields keep falling. The intensity of that trading — along with the actions of mortgage investors — accelerated the drop in Treasury yields.
The investment grade credit markets closed at YTD tights on Thursday evening, riding a wave of strong sentiment from a surprisingly dovish Fed statement on Wednesday. The story changed on Friday, however, with a decidedly softer tone fueled by concerns about the lack of growth globally. Credit is mixed as we go to print on Friday with major stock indices firmly in the red on the day. The 10yr Treasury will finish the week almost 10 basis points lower than where it started, which will likely mark a YTD low for the benchmark rate. After peaking at 3.24% in November of 2018, the 10yr has now completely retraced its steps to 2.43%, which is almost exactly where it opened in 2018. The extreme volatility that we have seen in rates over the past six months offers us a reminder of just how difficult it can be to accurately predict interest rate moves and this unpredictability is the reason that we at CAM focus on credit risk and the intermediate portion of the yield curve as opposed to trying to predict where rates will go next by making duration bets.
It was another solid week of issuance for corporate bowers, as companies brought $21.55bln in new corporate debt during the week. $88.125bln of debt has been priced in the month of March and the year-to-date tally of new issuance is $292.298bln according to data compiled by Bloomberg. The pace of 2019 IG issuance is trailing 2018 by 9%.
According to Wells Fargo, IG fund flows during the week of March 14-March 20 were +$4.5 billion. This brings YTD IG fund flows to +$62.222bln. 2019 flows to this juncture are up 2.43% relative to 2018.
Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were $2.3 billion and year to date flows stand at $12.7 billion. New issuance for the week was $8.4 billion and year to date HY is at $53.0 billion, which is -0% over the same period last year.
(Bloomberg) High Yield Market Highlights
S. junk bond returns hit 7 percent for the year-to-date as BB yields fell to a 13-month low after the Fed’s mid-week dove surprise.
S. high-yield funds have seen net inflows in 8 of the last 10 weeks
Junk bond rally also boosted by S&P 500 at a 5- month high, oil at a 4-month high
Supply was steady, with another $1.8b pricing led by ADT’s senior secured tranches
Senior secured notes dominated junk bond supply year-to-date accounting for 30% of the issuance activity, the highest proportion in at least 2 years
They accounted for 13% of the supply last year and 21% the year before
ADT cut its bond offering to $1.5b after dropping the $1.25b 8NC3 senior unsecured tranche as there was not enough demand for those notes at an acceptable rate
Both secured tranches priced at lower end of talk, had orders above $3b for the 2 tranches combined
With loan supply lagging this year, senior secured notes are being used to repay loans and/or fund acquisitions as in Power Solutions
High-yield returns YTD surged to 7%, the best in fixed income
Single-Bs beat CCCs for second time this year, with YTD return of 6.97%
BBs and CCCs were at 6.93%
Loans lag high yield, with YTD return of 4.2%
(Business Wire) B&G Foods Announces that Bill Herbes, EVP of Operations, Plans to Retire
B&G Foods announced today that William F. Herbes, the Company’s Executive Vice President of Operations, plans to retire at the end of December 2019. Mr. Herbes, age 64, has served as Executive Vice President of Operations since joining the Company in August 2009.
Commenting on Mr. Herbes’ retirement plans, Kenneth G. Romanzi, who currently serves as Executive Vice President and Chief Operating Officer and, as previously announced, will become B&G Foods’ next President and Chief Executive Officer on April 6, 2019, said, “Bill has been a very important member of our management team since joining B&G Foods almost ten years ago. It has been a privilege to work with Bill and I am delighted that Bill has agreed to remain with B&G Foods through year end and partner with Erich Fritz, our Executive Vice President and Chief Supply Chain Officer, to continue to evolve our operations to become even more efficient and cost effective.”
Robert C. Cantwell, President and Chief Executive Officer of B&G Foods said, “Bill has been a tremendous contributor to B&G Foods’ growth over the past ten years. Since assuming responsibility for our supply chain and manufacturing operations in 2009, our company’s net sales have more than tripled and our domestic and international sourcing and manufacturing operations and capabilities have greatly expanded. Mr. Herbes has played an integral role in our growth, including through post-M&A integration of numerous manufacturing facilities, distribution centers and co-pack arrangements, including B&G Foods’ two largest manufacturing facilities. Under Bill’s strong leadership, we also successfully established a frozen distribution network following our acquisition of the Green Giantbrand and successfully outsourced our shelf-stable distribution network to a third-party logistics provider. Over the years, Bill has also played a key role in our cost savings initiatives. I am very pleased that Bill will continue with B&G Foods through the remainder of 2019 and wish him the best of luck in his retirement.”
(PR Newswire) Steel Dynamics Provides First Quarter 2019 Earnings Guidance
Steel Dynamics provided first quarter 2019 earnings guidance in the range of $0.88 to $0.92 per diluted share. Comparatively, the company’s sequential fourth quarter 2018 earnings were $1.17 per diluted share and prior year first quarter earnings were $0.96 per diluted share. Fourth quarter 2018 results included additional company-wide performance-based compensation of $0.04 per diluted share and lower earnings of $0.10 per diluted share, associated with planned maintenance outages at the company’s liquid pig iron production facility and its two flat roll steel mills.
First quarter 2019 earnings from the company’s steel operations is expected to decrease in comparison to sequential fourth quarter results, primarily related to lower earnings from the company’s sheet operations. However, recent increases in sheet steel prices are having a positive impact, resulting in increased order activity and reconstituted order backlogs.
Overall steel shipments are expected to increase in the first quarter 2019, compared to fourth quarter 2018 results, and average quarterly steel product pricing is expected to decrease more than the cost of average scrap consumed. The company believes domestic steel consumption will continue to improve through the year.
(New York Times) Fed, Dimming Its Economic Outlook, Predicts No Rate Increases This Year
The Federal Reserve said Wednesday that the United States economy was slowing more than it had previously thought as it left interest rates unchanged and signaled little appetite for raising them again in the near future.
The Fed now expects 2.1 percent growth this year, down from the 2.3 percent it forecast in December. The outlook for 2020 is even more bleak, with the Fed now projecting growth of just 1.9 percent.
The downbeat assessment comes as the Fed sees signs of weakness in areas like consumer spending and business investment, which Mr. Powell said “suggest that growth is slowing somewhat more than expected.” Average monthly job growth, while strong, “appears to have stepped down from last year’s strong pace,” he added.
Powell tried to reassure markets by saying “economical fundamentals are still very strong,” but he acknowledged that recent developments both domestically and abroad were making it harder for the American economy to grow as quickly as it did last year.
Forecasts released at the end of the two-day meeting show the typical member of the Federal Open Market Committee now expects not to raise rates at all this year. Most officials now expect a single rate increase in 2020 and none in 2021.
The investment grade credit markets look to finish the week marginally tighter. After opening the week at 123, the OAS on the corporate index closed on Thursday at 121, near the YTD low of 120. The 10yr Treasury is 4 basis points lower on the week as we go to print and it is 15 basis points lower than where it closed on the first trading day of March.
It was yet another solid week of issuance as IG firms issued just over $25bln in new corporate debt during the week. New issue concessions remain razor thin and in some cases turned negative as investors “pay up” for the liquidity that it is afforded by the availability of new debt. At the midpoint of the month, $64bln in new debt has been issued which brings the YTD tally to $268.498bln according to data compiled by Bloomberg.
According to Wells Fargo, IG fund flows during the week of March 7-March 13 were +$4.9 billion. This brings YTD IG fund flows to +$49.968bln. 2019 flows to this juncture are up 1.39% relative to 2018.
(WSJ) $10 Billion Corporate Debt Sale Highlights Credit Market’s Recovery
The world’s largest maker of automotive batteries is set to sell more than $10 billion worth of speculative-grade debt Friday to fund its purchase by an investor-group led by Brookfield Business Partners LP, underscoring the recent resurgence in demand for low-rated bonds and loans.
Power Solutions, the automotive-battery business currently owned by Johnson Controls International, is poised to sell roughly $3.7 billion worth of secured and unsecured bonds, denominated in both dollars and euros, along with around $6.5 billion in loans, also split between euro and U.S. dollar tranches.
The long-anticipated sale is on track to be relatively easy for a large group of underwriting banks, as investors have eagerly embraced what many see as a stable business that is able to shoulder the large amount of debt being placed on it.
The expected completion of the Power Solutions deal is a testament to the improved tone in high-yield debt markets, several investors said. Though fears of an economic slowdown led to a sharp decline in bond and loan sales in the final months of 2018, issuance picked up in the middle of January and has been fairly steady since then.
Through Wednesday, businesses had sold a total of $106.9 billion of speculative-grade bonds and loans this year, according to LCD, a unit of S&P Global Market Intelligence. That is down from $162 billion in the same period last year.
Some investors cautioned that the likely success of the Power Solutions deal doesn’t necessarily mean other businesses will find it as easy to sell such a large amount of debt in the current market. Even using conservative assumptions, analysts expect the company should be able to generate ample free cash flow in the coming years. Its secured bonds and loans, in particular, appealed to investors who have been eager to buy debt at the higher end of the speculative-grade ratings scale.
Not everything about the deal pleased investors. Prospective buyers were able to make some changes to the package of investor protections, known as covenants, an unusual outcome for such an in-demand deal. Yet the result, some said, still gives the company’s owners plenty of room to pay themselves dividends and remove collateral from the business, in keeping with the long-term trend toward weaker covenants.
(Bloomberg) U.S. Junk Bonds May Be Signaling That It’s Time to Be Cautious
There are early signs that it’s time to be cautious now in U.S. junk bonds.
Investors seem reluctant to buy the weakest high-yield corporate securities, a potential signal of trouble ahead, according to Citigroup Inc. strategists. Ratings firms are downgrading speculative-grade companies at the fastest rate relative to upgrades since the start of 2016, according to data compiled by Bloomberg. And to sell their bonds, a handful of issuers including Scientific Games International Inc. have had to pay higher yields this month than dealers had expected.
For now, many investors are shrugging off those concerns. Junk bonds have reached record highs this year and are the best performing U.S. fixed-income sector, gaining more than 6.4 percent through Wednesday. A Bank of America Corp. survey of U.S. credit-fund managers found the lowest level of alarm about high-yield and investment-grade corporate bonds since 2014.
A handful of companies including Arrow Bidco LLC and Community Health Systems Inc. are feeling the impact of those concerns. The borrowers had to pay more than dealers expected to entice investors to buy bonds in recent weeks.
There are other reasons for investors to be cautious now. Economists surveyed by Bloomberg expect growth to slow in the U.S. over the next three years. U.S. corporate earnings growth could come under pressure as tax benefits subside, which should reset junk bond prices and generate “meaningful” negative excess returns in the coming weeks and months, Bank of America said. Corporate bankruptcy filings in the U.S. have jumped, according to a Bloomberg index.
Warning signs aren’t limited to the U.S. The European Central Bank has slashed its economic expansion forecasts for the region, China has lowered its goal for economic growth, and an increasing number of corporate borrowers there are struggling to repay debt obligations.
There are still positives for corporate-debt investors. More companies have been getting upgraded to investment grade than getting cut to junk, a trend that’s expected to continue this year, according to Barclays Plc strategists led by Bradley Rogoff. The highest ratings tier now makes up almost 46 percent of the overall junk market, near an all-time high. The size of the junk bond market has been shrinking for more than a year, in part because companies have borrowed more in the loan market, making the securities scarcer. And default rates remain low, although they are rising.
Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were $1.4 billion and year to date flows stand at $11.1 billion. New issuance for the week was $4.6 billion and year to date HY is at $42.7 billion, which is -12% over the same period last year.
(Bloomberg) High Yield Market Highlights
S. junk bonds extended this week’s rally, as dedicated funds received fresh cash inflows.
Yields held firm as oil rallied to close at a 4-month high after rising for 4 straight sessions
Returns were at new YTD highs across ratings, with high-yield index at 6.52%
Triple Cs were best performers yesterday, held top rank YTD, with 6.83% gain
BBs returned 6.35%, single-Bs 6.45%
Loans lagged high yield bonds, with YTD return of 4.2%
S. junk operating against backdrop of strong technicals as reflected in slow issuance activity, net inflows into retail funds, low default rate, steady corporate earnings
(Fierce Wireless) New details cause FCC to pause T-Mobile/Sprint merger for third time
The FCC has stopped the clock on a proposed merger between wireless carriers Sprint and T-Mobile. The agency said it has received “significant new information” regarding the deal and has opened up a three-week period ending March 28 for public comment. The pause comes on day 122 of the 180-day review period the FCC holds for mergers.
Opposition to the merger gained momentum when the Wireless Internet Service Providers Association (WISPA) joined a coalition of rural wireless providers that oppose the merger. The 4Competition Coalition is comprised of 25 organizations, including WISPA, Dish, C Spire and the Rural Wireless Association (RWA). The coalition has argued that the merger, which would reduce the number of nationwide wireless carriers to from four to three if successful, would hamper rural consumers’ access to wireless service. “The combined company would have significant new incentive and ability to raise prices and preemptively stamp out competition from newcomers. And the merger would result in the loss of tens of thousands of jobs in the process,” the coalition claims on its website.
Earlier this week, T-Mobile filed new plans for the combined company to provide residential broadband service. T-Mobile CEO John Legere seemed to respond to the opposition in a blog post this week, which claimed that the combined company will pose a competitive challenge to cable broadband providers.
“We’ll give millions of Americans—especially those in underserved rural areas—more choices and options for connecting to the internet and participating in the digital economy,” Legere wrote. “With the New T-Mobile and our unique 5G capabilities, we’ll be able to offer a fast and reliable alternative for in-home broadband.”
(Company Filing and CAM) AMC Entertainment notes downgraded to CCC+ by S&P
AMC launched a potential refinancing of their existing credit facilities. They intend to use a portion of the net proceeds of such refinancing to redeem all of the outstanding 5.875% Senior Subordinated Notes due 2022 and 6.00% Senior Secured Notes due 2023 pursuant to the provisions of the indentures pursuant to which such notes were issued. There can be no assurance as to whether and when such refinancing and redemption will occur and on what terms such refinancing will occur, if at all.
While the refinancing is for the most part leverage neutral, S&P lowered the ratings on the existing senior subordinated notes due to the added secured debt placed above the notes in the capital structure.
Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were -$1.2 billion and year to date flows stand at $9.7 billion. New issuance for the week was $5.0 billion and year to date HY is at $38.0 billion, which is -6% over the same period last year.
(Bloomberg) High Yield Market Highlights
S. junk bond yields jumped the most in four weeks, closing at a two-week high, as returns turned negative across ratings for a third consecutive session, the worst run since January. Triple C bonds suffered the biggest decline since December.
Yields rose in 5 of the last 9 trading sessions as S&P 500 dropped the most in 4 weeks to close at 3-week low
Equity fell for 4 straight sessions for first time since December
VIX rose for 4 straight sessions for the first time since October, closing at a 5-week high
Nervous junk bond investors withdrew cash from high yield funds, the first negative flow since January
Resilience of high yield was evident in steady pricing of new issues
Biggest LBO deal YTD, Power Solutions, had $15b in orders for senior secured and unsecured tranche combined, after just two days of roadshow
Junk bonds still remain best-performing in fixed income, with YTD return of 6.07%
CCC bonds fell 0.18% yesterday, have gained 6.38% YTD
High yield maintained lead over loans, which returned 4.16% YTD
S. junk bonds operate against the backdrop of strong technicals as reflected in slow issuance, low default rate, steady corporate earnings
(Bloomberg) CenturyLink Finds ‘Material’ Accounting Issues With Level 3
CenturyLink Inc. discovered a “material weakness” in accounting involving the value of assets acquired with the 2017 purchase of Level 3 Communications and notified regulators that its 10-K filing will be late.
CenturyLink said it found problems with “internal controls” in its books involving recording and “measuring fair value of assets and liabilities” it took over with the Level 3
acquisition, according to a filing Monday. The rural telephone company said it needs to audit the accounting before it can report its year-end numbers, but that the problem won’t cause any material changes to the results it reported Feb. 13.
Monroe, Louisiana-based CenturyLink bought Level 3 to strengthen its sales to businesses and cope with a long-running decline in landline demand. The company — one of the largest junk-bond issuers in the U.S. — is part of a challenging industry that includes Windstream Holdings Inc., which filed for bankruptcy protection last month.
(Bloomberg) Digital Colony Is Said to Weigh Bid for Zayo
Digital Colony, a communications infrastructure-focused firm formed by Tom Barrack’s Colony Capital Inc. and Digital Bridge Holdings LLC, is part of a potential buyer group weighing a bid for Zayo Group Holdings Inc., according to a person with knowledge of the matter.
The group, led by Digital Colony and investment firm EQT, has fully committed debt financing, said the person, who asked not to be named because the matter is private. A Digital Colony representative didn’t immediately respond to a request for comment, and an EQT representative declined to comment.
Zayo is a Boulder, Colorado-based owner of fiber networks across North America and Europe on Wednesday said it’s “evaluating strategic alternatives.”
Zayo, led by Chief Executive Officer Dan Caruso, postponed its analyst day, and said it will take “a minimum of several weeks to months” to consider its options, though there’s no set timetable nor assurance a strategic alternative will result.
(Bloomberg) T-Mobile’s Sprint Deal Draws State Concerns Over Consumer Harm
State antitrust enforcers are expressing deep concerns that T-Mobile US Inc.’s proposed takeover of Sprint Corp. could raise prices for consumers, signaling they might seek to thwart the deal.
Some state attorneys general who are investigating the $26 billion transaction took the unusual step this week of publicly voicing worries that the combination could harm competition, offering insight for the first time into how they view the tie- up.
Maryland Attorney General Brian Frosh, a Democrat, said combining T-Mobile and Sprint would further concentrate an already consolidated industry by leaving just three national carriers. “That’s dangerous for competition. That’s dangerous for consumers,” Frosh said in an interview on the sidelines of an annual conference in Washington for state attorneys general.
The comments come after more than a dozen states joined to investigate the deal in parallel with the Justice Department and the Federal Communications Commission, which are nearing the end of their reviews.
The tie-up has been widely criticized by consumer groups and Democratic lawmakers who want officials to oppose the deal. The states can sue to block the merger on antitrust grounds even if federal officials approve the takeover.
The Finance Companies, Energy, and Utilities sectors were the best performers during the quarter, posting returns of 9.00%, 8.27%, and 7.81%, respectively. On the other hand, Other Financial, Insurance, and Transportation were the worst performing sectors, posting returns of 5.12%, 6.33%, and 6.34%, respectively. At the industry level, refining, oil field services, pharma, and supermarkets all posted the best returns. The refining industry (12.20%) posted the highest return. The lowest performing industries during the quarter were retail REITs, office REITs, airlines, and life insurance. The retail REIT industry (2.86%) posted the lowest return.
