A slew of opportunistic deals, led by Wal-Mart's $1.5bn blowout 10 year global, hit the US bond market this week as better than expected first quarter earnings and continued strong cash levels sent already tight spreads to even tighter levels. A week that started out with next to nothing on the calendar ended up seeing more than $6.45bn of deals, all of which were priced tighter than expected and tightened still further on the break.
"I have never seen a bond market so tilted in favour of new issue spread tightening in a long time," said a syndicate head at one of the biggest bond houses on Wall Street. "Demand is just in a complete imbalance with supply."
Wal-Mart was the first to seize the opportunity to lock in record low absolute yields by issuing a $1.5bn 10 year at a mere 4.55% coupon.
The fact that it was Wal-Mart's first 10 year benchmark issue since 1999 started a feeding frenzy among investors starved of good quality 10 year industrial paper.
Bookrunners were swamped with more than $4bn of orders in less than two hours, enabling Wal-Mart to tighten pricing to a launch spread of 58bp, 2bp inside what was considered fair value. It then traded as tight as 51bp and settled around 53bp by Thursday afternoon.
Wal-Mart's deal on Tuesday was quickly followed by the Canadian Province of British Colombia's $500m 10 year global at 40bp.
"After those two deals the market just took off," said one banker. "The tighter spread environment has really got people excited. After Wal-Mart we saw Clear Channel issue $500m, Emerson Electric do $250m and Pitney Bowes issue $350m, all of which are one-off opportunistic style issuers."
The Province of Ontario is expected to price a $500m five year global bond on Friday morning, with price talk at 31bp.
Even airline leasing company International Lease Finance Corp (ILFC), placed $1bn of five and 10 year global bonds late yesterday (Thursday) afternoon at spreads of 175bp and 200bp, despite the fact that its deal came as AMR Corp, owner of American Airlines, went careering toward Chapter 11 bankruptcy protection.
"Everyone knows what is going on in the airline industry, so to get a deal done by ILFC says everything you need to say about the strength of the market right now," said one banker.
Investors are being forced to make more daring bets on new issues such as ILFC's to be able to outperform the market as a whole.
"You cannot continually buy bonds that trade at 50bp over and expect to earn your keep," said one banker. "IFLC offers yield and the possibility of return and given its A1/AA- ratings it's a good bet at these spreads, even though it's in a difficult industry."
April is turning out to be the biggest month of spread tightening this year.
"We've been to hell and back in one short year," said Krishna Memani, head of credit strategy at CSFB, referring to the crisis of confidence that gripped the high grade credit market last year.
"Our Liquid US Corporate Index for the month of April is in 21bp," he added. "That means north of 100bp of out-performance on an excess return basis, which is absolutely remarkable given how tight spreads were to begin with."
The closely followed Lehman US Corporate Index has tightened 17bp month-to-date to an option-adjusted spread of 142bp, its tightest level since March 2000.
At current spreads the market has gone beyond fair value, according to Krishna.
"If you look at the fundamental improvement in credit quality... there has been very modest improvement," he said. Economic indicators are also yet to show a strong growth trend in the US.
That said, Memani joins others in forecasting continued spread compression, albeit at a less dramatic pace, if only because the mis-match between demand and supply should continue.
That continued trend, the fact that war is now behind us, and the better than expected earnings, prompted Bear Stearns' credit strategist Simon Ballard to upgrade its short-term credit strategy recommendation on corporate bonds to marginal overweight versus the benchmark index.
"We now have a critical mass of the first quarter earnings season behind us, with earnings growth apparently running at an encouraging 10.6% so far," he said.
