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The window for investment-grade bond issuers is expected to remain open in the second half, with government intervention expected to boost the upside for financial issuers, according to multiple capital markets experts interviewed by Dealreporter.
Both fundamentals and the economic outlook remain weak, which in turn impacted the way corporate America is using newly raised capital, according to Hans Mikkelsen, a high-grade credit strategist at Banc of America Securities-Merrill Lynch.
On the pricing front, bond traders expect spreads to continue to tighten, though some volatility is likely around earnings season. New issue premiums, according to one trader, are likely to remain low with fewer assets to chase.
While the market seems to be pricing a recovery in the second half, capital markets sources continue to be cautious on the credit market, where there is less upside and greater downside risk.
Excluding government-backed issuance, US corporations raised around USD 460bn in high-grade debt, capital markets sources said, and expect full-year investment grade issuance to approach USD 950bn - USD 1 trillion.
Approximately USD 114bn of non-financial investment grade debt matures in 2009, with USD 54bn being satisfied in 1H09, according to Mikkelsen. His estimates for investment grade maturities for financials in 2009 is approximately USD 507bn.
“The investment-grade bond market has been front-loaded with a record issuance in 1H09,” Mikkelsen said. He further added that if there is a pullback in 2H09 high-grade issuances, the impact would be felt by cyclical issuers and lower investment grade companies. In his view, defensive sectors, such as Consumer Products and Industrial Products, should continue to benefit from investor demand for the remainder of the year.
Proceeds from most debt issuances in the straight bond markets have either been tied to pre-funding acquisitions, as in the case of Roche (RHHBY, AA-/A2), Merck (NYSE: MRK, AA-/Aa3)) and Pfizer (NYSE: PFE. AAA/Aa2), or post-M&A restructuring for companies such as Dow Chemical Company (NYSE: DOW, BBB-/Baa3), and Hewlett Packard (NYSE: HPQ, A/A2).
However, some companies like Dell (NASDAQ: DELL, A-/A2), Wal-Mart (NYSE: WMT, AA/Aa2), and Microsoft (NASDAQ: MSFT, AAA/Aaa) opportunistically issued new debt only to take advantage of extremely favorable rates. Others such as Alcoa (NYSE: AA, BBB-/Baa3), Caterpillar (NYSE: CAT, A/A2), Time Warner Cable (NYSE: TWC, BBB/Baa2) and Comcast (NASDAQ: CMCSA, BBB+/Baa1) used new deals to repay credit facility outstandings, term out CP and repay upcoming maturities.
Though the convertible bond market was shut off for about four or five months in 2H08, it started showing signs of life toward the end of 1Q09. New issuance of convertibles has totaled USD 18.3bn, year to date, said Venu Krishna, head of US equity-linked strategies at Barclays Capital. Given the market capacity to absorb USD 50bn-USD 60bn annually, it appears current issuance levels have yet to satisfy the market’s potential, he said.
“Investors are exercising more discipline in how the issues are priced,” said Krishna, commenting on the seemingly weaker deal flow in the convertible market.
Convertible arbitrage hedge funds that comprised 80% - 85% of the convertible market in the past now make up only 50% - 60%, Krishna said. Stepping in are hedge funds with no previous exposure to convertibles and more traditional asset managers that have either debt or equity exposure to issuers in the convertible market seeking relative-value opportunities, Krishna said.
According to Krishna, convertible bond investors have reaped USD 30bn from redeeming notes, exercising put options or tendering into buybacks of outstanding notes. Financial institutions contributed to this lump sum when they converted their preferred securities. Earlier this year, Bank of America Corporation (NYSE:BAC, A/A2) converted USD 3.1bn out of its USD 6.9bn convertible preferred issue via privately negotiated transactions. Nabors Industries (NYSE: NBR, BBB+/Baa1), another example, reduced the notional amount outstanding of its 2011 USD 2.75bn converts by USD 900m.
Companies realize that this is not the environment to be executing business with a more complex capital structure, said one capital markets source. Declines in share repurchase activity and reduced dividends highlight the fact that liquidity and strong balance sheets are a priority, he noted. Companies are now carrying high cash balances as a result of aggressive funding activities and adjustments in dividend policies and buyback programs.
“Refunding risk appears to have significantly diminished,” noted Kevin Cassidy, Senior Credit Officer at Moody’s.
However, despite some degree of overcapitalization, it is too early in the cycle and there is still too much uncertainty for companies to review their dividend policies, Cassidy said.
“It sends the wrong signal if down the road a company has to go back and cut dividends,” he added.
Instead, at this point companies are starting to regain focus of future growth by reinstating capex programs and looking for strategic asset purchases. A second capital markets source specializing in the energy space said this sector is a prime example of this trend, with liquidity being preserved to ensure capex growth when commodity prices stabilize or seek asset buys.
Recent deals in the energy space by companies such as Occidental Petroleum (NYSE: OXY, A/A2), and Talisman Energy (TO: TLM, BBB/Baa2) demonstrate that sufficiently capitalized companies are ready to put the new capital to use.
It remains to be seen whether earnings season supports the green shoots or if the outlook for earnings remains weak over the near term, noted the first capital markets source. However, the market has a lot of technical factors driving it as risk appetite returns to the market. “This makes sense as you can’t keep investments only in cash and short term safety (like US Treasuries) forever,” he said.
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