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Paucity Of High-Grade Corporate Bonds Helps Support Prices
Dow Jones, June 29, 2010

The World Cup isn't the only place where defensive tactics are on display.

An analysis of investment-grade bond issuance from the first half of the year shows most companies have opted to guard their bottom lines rather than raise money for aggressive expansion.

U.S.-marketed investment-grade issuance fell to $328.1 billion in the first half, excluding government guaranteed debt, from $396.7 billion in the first half of 2009, according to Dealogic figures through June 28.

The volume fell by nearly half between quarters, with $217 billion in the first and $111 billion in the second quarter.

"The issue calendar has been benign to disappointing, which is supporting our belief that credit is a good place to be in" as an investor, said Peter Vutz, head of credit at Dwight Asset Management.

Those who did need the money to refinance debt, take out bank lines or term out commercial paper enjoyed record-low pricing as investors fought to take their money off the sidelines and put it to work.

In the first quarter, demand outstripped supply so much that there were negative new issue premiums, which means newly issued bonds would price cheaper than bonds trading in the secondary market, said Matt Toms, head of U.S. public fixed-income at ING Investment Management.

In February, Procter & Gamble Co. (PG) sold $1.25 billion of 2.5-year notes with a coupon of just 1.375% to yield 55 basis points over Treasurys.

"Volumes are down meaningfully versus 2009, but I wouldn't call it a half-year period of inactivity," said Paul Spivack, managing director and global head of fixed income syndicate at Morgan Stanley. "When we are doing deals they are being met with oversubscription."

High-yield corporates were helped by the lack of investment-grade supply, issuing $116.6 billion of bonds in the first half compared with $61 billion for the first half of 2009. Only a tiny share of those issuers--selling $12.17 billion of bonds--were financial institutions, which had pre-funded extensively through the U.S. government's Temporary Liquidity Guarantee Program in 2009.

"Aggregate balance-sheet cash is as high as it's ever been," said David James, vice president of fixed income at broker-dealer Wall Street Access. "Companies have cut back a lot and they haven't got constrained on their plant, property and equipment because there is so much slack in the economy."

Issuance was expected to tail off after the government guarantees were removed, but many market participants said they expected financials to make up a larger part share of new bond sales in 2010.

Andrew Karp, head of investment-grade syndicate at Bank of America Merrill Lynch forecasted $800 billion of new U.S. investment-grade issuance for 2010, of which $500 million would be from financials and $300 billion would be from other corporations.

So far the other corporations seem to be on track, issuing $162.4 billion through June 28, whereas financials are well behind expectations at $188.1 billion.

"Financial issuance is running below our forecast though it has definitely picked up in the last couple of weeks," Karp said.
Coming To Market
Financials flocked to market in recent weeks just as there was more visibility over forthcoming regulation. Before then, they had been reticent after a Securities and Exchange Commission investigation into Goldman Sachs (GS) sent spreads wider in the sector.

HSBC (HBC, 0005.HK) and GE Capital, the financial arm of General Electric Corp. (GE) issued $2 billion and $1 billion five-year notes, respectively, last Monday garnering a coupon of 3.5% and a spread of 1.5 percentage points over Treasurys. Jefferies Group (JEF) issued $400 million in bonds last Wednesday with a coupon of 6.875% and a spread of 3.90 percentage points over Treasurys.

"This proves that there is still sufficient appetite for financial issuance," said Karp.

In the second quarter, issuers were frequently derailed by volatility in the credit and equity markets, particularly over the last six to eight weeks.

"We were experiencing a bipolar market where for every five days of business there was only one or two days to access the market," said Peter Aherne, head of capital markets and syndicate for the Americas at Citigroup.

Recent data have underscored the fragility of the U.S. economy. Durable goods orders fell 1.1% in May, better than the 1.4% drop expected but still the first decline in six months. "The whole manufacturing sector had a really nice rebound, but even some of the manufacturing data seems like it is starting to soften now," said Michael Collins, senior investment officer at Prudential Fixed Income.

Another bearish signal came over the weekend as three high-yield corporates--Isle of Capri Casinos, Inc. (ISLE), Affinia Group and Omega Healthcare Investors, Inc. (OHI)--announced equity offerings to pay down debt.

With European woes still framing the backdrop, the next few weeks are tipped to be even more quiet than forecast. There is, however, a reasonable backlog beginning to develop.

"We expect both domestic and Yankee issuers to be very active through the second half as issuers look to get ahead of debt maturities," said Aherne. Yankee issuers are foreign companies that sell dollar-denominated bonds in the U.S.

If markets start to stabilize, mergers and acquisitions should pick up, driving new issuance. The volume of U.S. M&A this year through June 28 fell 14%, to $391.4 billion, from the same period in 2009.

Share repurchases may also drive bond sales. Biotechnology company Genzyme Corp. (GENZ) sold $1 billion in bonds mid-June that it intends to use to buy back stock.

Credit investors are awash with cash, but they are constrained by the potential contagion coming out of the euro zone and other looming outliers such as the BP oil spill that threaten to cut off supply.

Vutz said his firm had invested heavily in corporate investment-grade debt, but had started to pare back late in the first quarter "which in essence coincided with the Greek debt crisis."

There is excessive demand in higher yielding, longer-duration bonds, which issuers have largely shied away from because of the big difference between yields on the 10-year and 30-year Treasury securities.

The 10-year was yielding less than 3% Tuesday, the lowest since April 2009, and the 30-year was yielding less than 4%, the lowest since October 2009.

If the supply doesn't come, there will be a rally in secondaries, said Tom Lewis, managing director and head of U.S. Debt Syndicate at Morgan Stanley.

The most desirable bond during the second quarter, according to net flows in secondary trading from MarketAxess, was Bank of America's



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