Bank and Capital Markets New Issue Review
Comment of the Day

August 16 2012

Commentary by Eoin Treacy

Bank and Capital Markets New Issue Review

Thanks to a subscriber for this informative report from Ernst & Young which may be of interest to subscribers. Here is a section:
The week saw multiple jumbo issuances across the debt capital markets, with a notable 14 issuers accessing the market for US$1 billion or more, PepsiCo (Aa3, A-, A) was one such issuer, taking advantage of yields on US corporate debt falling to the lowest levels for a year. The US beverage manufacturer issued US$2.5billion in three tranches; a US$900 million 3-year tranche issued at 0.70% ((T+33bps), a US$1 billion 5-year tranche issued at 1.2% (T+63bps), a US$600 million 30-year tranche, finding support at 3.60% (T+95bps). Another jumbo issue was from US corporate Altria (Baa1, BBB, BBB+) who successfully issued US$2.8 billion across 10 and 30-years at the tighter end of pricing, with the issues over 2.5 times oversubscribed.

Deal activity was not limited to the US, although European volumes were much lower, continuing the slow summer for Euro issuance. Procter & Gamble (Aa3, AA-, NR) issued €1 billion of 10-year bonds at MS +25bps; this was the company's first Euro issuance since October 2007, and attracted an order book of €6 billion. The company also raised US$1 billion in 10-years at T+38bps. Activity was also seen in the Sterling market, including German car manufacturer and capital market favourite, Volkswagen (A3, A-, NR), issuing £250 million at G+110bps.

Eoin Treacy's view Over the last few years, the compression of yields in debt markets has allowed corporations to lock in the lowest cost of capital they have seen in decades. As noted previously, a number of companies have even gone so far as to issue 100-year bonds.

AA USD corporate bond spreads have returned to test the 100 basis points area and a clear upward dynamic will be required to question potential for additional compression. This move helps to reflect the momentum that has driven interest in fixed income securities over the last year.

In only the last couple of weeks Siemens announced a share buyback program that will be funded with new debt. The company's 2019 bonds currently trade at a yield of 2.36% and the share yields more than 4%. This divergence highlights both the compression in the bond market but also the fact that the equity markets have been largely neglected by investors. While it is increasingly attractive for corporations to opt for debt rather than equity, one really needs to ask whether that is the best option from the perspective of an investor.

As David pointed out yesterday and veteran investors will have experienced, increasing supply is a significant headwind for investment returns. This is certainly an issue in bond markets; both corporate and sovereign. However, as more companies opt for debt issuance rather than equity and as buybacks shrink the available number of shares for a considerable number of companies, high quality equities with a solid record of dividend increases and strong balances sheets could potentially become collectors' items.

As an exercise to identify companies with low debt to equity ratios I performed a search on Bloomberg for those with a ratio of less than 20% and a market cap of greater than $5 billion. What is particularly notable from the results is the reliance of technology companies on equity capital. A significant number have no debt. As more companies move from a growth footing to more evenly distributed cash flows they have begun to pay dividends. In such circumstances the relative allure of the fixed income market is likely to become a more compelling prospect. In turn this should help reduce the risk of further dilution of equity capital.

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