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CREDIT MARKETS: Goldman Sachs, Morgan Stanley Tap Debt Markets For Combined $2.8Bln

The Wall Street Journal Online, 26th October 2010

A trio of financial institutions were in the market to sell bonds Tuesday, perhaps taking advantage of near record low borrowing rates in case the market turns after next week's Congressional elections, Fed monetary policy meeting and unemployment data.

Goldman Sachs (GS) took center stage, selling $1.3 billion in 50-year senior bonds primarily targeted at retail, or private, investors. Up to now, its longest-dated senior debt went out 30 years.  

Both corporate and government debt is widely tipped to rally once the Fed's bond purchasing scheme, aimed at boosting confidence in the markets, is under way. But it is not a foregone conclusion.

"I think the Fed will probably err to the side of over-stimulating," said Anthony Valeri, investment strategist in fixed income for Boston-based LPL Financial in an interview.

Some $500 billion to $1 trillion of Fed monetary easing is already priced into the bond market. After five-year Treasury Inflation-Protected Securities sold for the first time at a negative yield on Monday of minus 0.55%, it already seems to be working. "I'm sure they are pleased with the result they have got so far," said Valeri.  

There were also reports on Tuesday of funds flowing further into the equity market, which has been less volatile lately than earlier in the year. Third-quarter earnings from the companies that make up the S&P 500 stock index are up 28% on last year, according to Rich Lee, managing director in fixed-income with Wall Street Access in New York, well above the 9% average since 1998.  

"We think the fact that stocks are not down in the face of a rallying a result of these allocations," said Andrew Brenner, head of global emerging markets fixed income at Guggenheim Securities.

Investment-Grade Bonds  

Goldman's 50-year deal underscores the demand for additional yield possible on longer-dated paper. Bonds have been getting longer as investors look for instruments that can earn them more income over government debt.

Among high-grade corporate bonds, three-year debt went from being 21% of total U.S. marketed volume last year through mid-October to 11% this year to date. Similarly, 30-year debt went from being 5% of overall investment-grade issuance to 9% so far this year, according to Dealogic data.

Also in the market Tuesday was Morgan Stanley (MS), which sold $1.5 billion in five-year bonds with a 3.45% coupon to yield 3.464%, or a risk premium of 225 basis points over comparable Treasurys. Price talk had been 230 basis points.  

India's Axis Bank (AXBKY, 532215.BY) separately sold $500 million of six-year notes with a 4.75% coupon to yield 4.834%, a spread of 360 basis points over Treasurys.  

Goldman's deal was upsized from an original $250 million on demand. The bonds, which will be callable at par after just five years, sold at par to yield 6.125%, at the tight end of guidance. About 20% of the book was institutional buyers, according to one person familiar with the sale. Goldman declined to comment.

Financial institutions have been largely absent in recent weeks, as bank spreads widened out following the alleged mortgage foreclosures scandal. Morgan Stanley and Goldman Sachs were not tied to those headlines.

"Banks will probably hold off for now---or do smaller issuance. But ultimately I think most of the financials still come to market because all-in yields are so low," said LPL's Valeri.  

Outside of financial institutions, Korea Gas Corp. (036460.SE) sold $500 million in 4.25% 10-year bonds at a slight discount to yield 4.312%, or 170 basis points over Treasurys.  

Trading in credit default swaps was relatively muted, save for a few special situations.  

The cost to insure bonds issued by Cardinal Health Inc. (CAH) against non-payment or default fell 60% in mid-afternoon trading Tuesday after the drug distributor brushed off rumors it was in buyout talks.

The insurance, sold in the form of derivatives called credit default swaps, were quoted at 92 basis points, equivalent to $92,000 a year to cover $10 million of debt for five years, from 149 basis points before the statement dismissing talk of a potential leveraged buyout, or LBO.  

On Tuesday morning, the credit default swaps were quoted as high as $165,000 a year, according to data provider Markit, up from $143,000 at Monday night's close.  

CDS on healthcare billing and claims company McKesson Corp. (MCK) were similarly improved after the LBO dismissal, quoted at $80,000, down from $90,000 at lunchtime and $97,000 at Monday's close.

The price of insuring both companies' bonds rose dramatically in the last two weeks because of the initial rumors, from $58,000 a year in the case of Cardinal on October 12 and $46,000 in the case of McKesson.  

"There doesn't appear to be any foundation for these rumours," said Gavan Nolan, vice president in credit research at Markit in London in a note, "and the firms' stock prices have been relatively unaffected. Those who can remember the days pre-credit crisis will be familiar with this pattern."  

Cardinal's 5.5% bonds maturing in June 2013 were trading 12 basis points wider on the day because of the rumors, at 126 basis points over super-safe Treasurys, for a yield of 1.838% versus 1.742% on Monday. Yields rise as prices on bonds fall, reflecting increased risk.  

McKesson's 5.25% bonds due March 2013 were 5 basis points improved, at a spread of 83 basis points over Treasurys, compared to 88 basis points on Monday, according to online trading platform MarketAxess

Junk Bonds  

The high-yield market was fairly flat Tuesday, as new issuance also took a day off.  

Ford Motor Co.'s (F) 7.45% long bonds due 2031 gained 1.625 points, to 114.625 cents on the dollar, according to MarketAxess, after Ford reported a $1.7 billion third-quarter profit and plans for further debt reduction.  

Price guidance for Momentive Specialty Chemicals Inc.'s $440 million offering of second-priority senior secured notes due 2020 is in the area of 9.25%. That's the same guidance for the dollar-denominated part of Momentive Performance Materials Inc.'s two-part dollar-euro offering of $840 million worth of second-priority 10-year notes.  

Proceeds will fund cash tender offers for outstanding notes. Momentive Specialty Chemicals is formerly known as Hexion Specialty Chemicals, which Apollo Management is merging with Momentive Performance Materials.

The deals are expected to price Wednesday via joint bookrunners J.P. Morgan Chase (JPM), Citigroup (C), Credit Suisse (CS, CSGN.VX), Morgan Stanley, UBS (UBS, UBSN.VX), Bank of America Merrill Lynch, Deutsche Bank (DB, DBK.XE) and Goldman Sachs.  

The high yield bond market has become more tolerant of risk as shown by the $27.2 billion of bonds rated less than B3 for 2010 to date, according to Moody's Investors Service, and the lowest-rated bonds currently appear overpriced compared with the overall high yield bond market.  

"However, it may be a stretch to view the latest upturn by the issuance of bonds graded less than B3 as indicating a potentially destabilizing tolerance of risk," wrote Moody's economist John Lonski on Tuesday.  

Barclays credit strategist Brad Rogoff on Tuesday said that leveraged loans are starting to look more favorable compared with high-yield bonds, with upside in U.S. high yield appearing more limited. Rogoff said the yield differential between the two has compressed significantly and that "loans look interesting on a relative-value basis."

Asset-Backed Securities  

The asset-backed securities market, where consumer debt is bundled into loans and sold, will continue to be a "big piece" of Ford Motor Co.'s (F) funding plan, the auto maker's treasurer said Tuesday in an interview.

The Dearborn, Mich., auto maker is the top-ranked issuer of asset-backed bonds so far this year, according to data from Royal Bank of Scotland. Ford has sold about $8 billion worth of bonds in 2010. "It's not a record we necessarily care about," said Neil Schloss, Ford vice president and treasurer. "Our job is to make sure we have enough financing for our dealers and customers."

That said, he pointed out robust sales at increasingly low yields indicate what investors think about Ford's assets. "The investors know the consistency of the pool. When we come to market, investors know what we are selling even before a deal is put together," he said.

Investors are partial to Ford's asset-backed bonds because the company offers enhanced credit protection for senior bond-holders. Auto ABS also have a strong ratings track record, having performed well even during the credit crisis, unlike the counterpart in the mortgage world.

"A Ford deal is a Ford deal," Schloss said. "When we talk to investors, at ABS conferences, one thing we continue to hear is about the consistency of our assets and structures. It doesn't matter if its retail or wholesale but investors value the consistency of what we originate."

For Ford, whose debt is junk-rated but whose asset-backed securities get more benign treatment, the cost of issuing asset-backed bonds is lower. Just last week, Ford sold an $819.16 million bond via its Ford Credit Auto Lease Trust that had among the lowest yields the company has had to offer, at under 1%.

On Tuesday, Ford reported a third-quarter profit of $1.7 billion.


The rise in 10-year Treasury yields to 2.6% created strong demand for higher coupon mortgage bonds, but reduced bids for lower coupons. A higher rate means mortgage rates can go up, and fewer chances of prepayment. This led buyers to prefer higher coupons. Similarly, a higher rate also means that fewer new homeowners are likely to be lured into buying a home based on the record-low rates. As a result, buyers showed little interest in the current, lower-coupon bonds. The current coupon was more than 3 basis point s wider, at 152 basis points over comparable Treasury yields. Supply, at $2 billion, also added to the pressure.  

Meanwhile, BNP Paribas (BNPQY, BNP.FR) sold $2 billion, five-year covered bonds at 70 basis points over mid-swaps. The deal was backed by residential home loans to homeowners in France.


After a quiet start, tax-free municipal bond prices were decidedly weaker Tuesday afternoon, down around 5 to 6 basis points in price generally, said Miller Tabak Chief Executive Michael Pietronico.

There are several reasons why this is happening, he said, including "mega supply" in munis--the 30-day visible supply is hovering around $17 billion--and people talking about Monday's five-year TIPS auction coming at its first-ever negative yield. "Inflation fears are beginning to permeate, just the way the Fed wants it," Pietronico said.

Meanwhile, CPS Energy, the nation's largest municipally owned natural gas and electric utility, plans to go ahead with an offer to sell $500 million in taxable Build America Bonds this week, despite news that the Internal Revenue Service is auditing one of its prior debt sales.

The utility, which sells its electric and gas system revenue bonds under the name of the city of San Antonio, Texas, shouldn't have any trouble finding buyers, market participants said, because it is a well-respected issuer.

The audit, which relates to prior Build America Bonds, or BABs, sold in June 2009, also appears to be random, not targeted, they added.

BABs are taxable securities created through the federal stimulus program last year that pay higher interest rates than traditional tax-exempt municipal securities.

The only thing that could have the potential to pressure the CPS sale, expected to price Thursday, is the hefty amount of BABs issuance expected this week and the rest of the year in the market at large, one market participant said. There is still uncertainty about the extension of the BAB program beyond Dec. 31, so a rush of issuance is expected.


The U.S. government sold new two-year notes at a record low yield for the sixth month in a row Tuesday, a sign of the strong demand for Treasurys amid expectations the Federal Reserve will unveil another large-scale bond buying program next week.

Treasury prices, however, were lower, as investors remained mindful of the week's remaining debt sales. The $35 billion two-year auction was the second leg of a $109 billion debt package this week. On Wednesday, the government will sell $35 billion in five-year notes, and Thursday it will offer $29 billion in seven-year Treasurys.

In afternoon trading, the two-year Treasury note was off by 2/32 to 0.395%, the 10-year Treasury was off by 21/32 to yield 2.643% and the 30-year Treasury was down by 1 15/32 to yield 4.001%.

The highlight of the day Tuesday was the two-year auction. The government sold $35 billion in two-year notes for a record low 0.400% yield after selling two-years in September for a record low 0.44%.

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