CreditSights: Gearing Up For Auto Supply
Along with death and taxes, volatility in the auto sector appears to be one of life's certainties and although there is no shortage of news drivers, rumors of forthcoming supply are up there among the best reasons for causing spreads to widen. The market has been very successful at predicting two dozen of the last two auto bond deals but once the "preconditions" are deemed to be optimal, the rumors begin nonetheless. Given the sector's substantial funding needs and the fact that, when they do come to market they do so in size, investor's hyper-sensitivity to this dynamic is not surprising. Being sensitive to issuance doesn't necessarily make the market any more accurate in predicting it however, and this well may reflect how many factors affect the timing of bond deals.
At the surface, the potential to capture the advantage of the substantial recent spread rally looks attractive. But in terms of its impact on the effective cost of borrowing, the spread movement is overshadowed, not only by last month's move in absolute rates, but by the potential for rates to rise further. If the release of April payrolls data in the U.S. this week confirms the strength that was evident in the March employment numbers, then we could be in for another sharp move higher in yields. But the more salient point is that while rates may or may not be higher in a month, they will certainly be higher in a year. From that perspective, the "optimal" funding conditions for any issuer facing a heavy refinancing schedule hinges on timing; the sooner, the better.
Ford and GM certainly qualify for the heavy financing schedule description. Given the substantial level of these near-term borrowing needs, it is little wonder that auto investors jump every time they hear the word "supply." The picture becomes even more interesting if one looks beyond this year and considers the enormous consolidated debt maturities of auto companies and their financing arms over the next four or five years.
It is possible that the car-making giants will consider the current appetite for auto paper in the dollar market, the comparative lack of dollar issuance in recent years, the success of GM's 2003 super-sized deal and the coming rising rate environment and see an opportunity to pre-fund a large portion of their future year's maturities at today's appealing rates.
The market took GM spreads some 50 basis points wider in June last year as the pension-funding mega-deal was launched. At the time, the aggregate option-adjusted spread on the Merrill Lynch High Grade Corporate Index was 183 basis points. It is currently almost 100 basis points tighter and so one can reasonably argue that, should a substantial deal auto deal come to market, spreads would gap wider but by a lesser degree than was seen a year ago. Even if spreads were to move by fully this amount, the cost to the issuer would likely pale against the potential savings that could be captured by pre-funding a substantial portion of future year maturities ahead of further absolute rate increases, making the proposition an attractive one for a company willing to take a bold move with its financing requirements.
We hardly need to point out that this is exactly the style GM exhibited last year as it capitalized on near-term positive momentum to address long-term funding requirements, to the ultimate applause of everyone. Nor do we need to highlight that in a rising rate environment, companies with large financing needs must cope with a rising level of investor scrutiny. The market seems to be expecting supply. It could get more than it bargained for.
Analysis by CreditSights, Inc., an independent online credit research platform. Call (212) 340-3888 or visit www.CreditSights.com for more information.
