Over the past month, the COVID-19 pandemic and the Russian/Saudi oil confrontation have given rise to historic movements in several markets and seemingly every asset class:
- US Treasury Rates: The 10yr US Treasury dropped from ~1.20% at the start of March to an end of day low of 0.543% by March 9th, before rising back to over 1.20% and “settling” back in around 0.80% for most of last week. In the meantime, the 30yr US Treasury moved intraday by over 5 points for 12 straight days from March 6th to March 23rd.
- Commodities: Within a period of roughly two weeks, West Texas Intermediate (“WTI”) Crude lost almost 55%, falling from ~$45/barrel at the start of the month to an 18-year low of $20.37/barrel on March 18th. Additionally, gold initially rose ~7%, before dropping over 11% and then retracing 12% higher to $1,660.
- Equities: The S&P 500 lost over 28% between March 4th and March 23rd. During that same period, the index saw only three intraday moves of less than 2% and the Volatility Index (“VIX”) more than doubled from ~$40 to $82.69.
- Investment Grade (IG) Spreads: The ICE Bond IG Index started the month at an Option Adjusted Spread (“OAS”) of +130. It took nine days for the spread to move above +200, five additional trading days for it to break into +300 territory and only four days to top out at +401 on Monday the 23rd. By Friday, we retraced back down thru +325.
- Commercial Paper (CP): Despite the Fed cutting rates by 150 basis points (“bps”), Tier 2 & Tier 3 issuers lost access to the CP market and Tier 1 issuers started to experience diminished liquidity as spreads increased. Many investors fled credit in the money markets and withdrew funds from Prime Funds in favor of Government Money Funds. By mid-March the majority of Tier 3 and many Tier 2 borrowers had exited the market and were tapping credit facilities or alternate liquidity options.
Despite this whipsawing activity, the IG new issue market has set records for total volume and investor demand, as measured by over-subscription rates. After six days of no IG volume to end February (longest non-Holiday streak since February 2016), the IG market reopened the week of March 3rd with $30bn of supply coming to market. Initially, transactions were well-received, with issuers paying minimal concessions (~5bps). However, as the week wore on, and broader market volatility increased, issuers had less price leverage. As a result, new issue concessions increased to an average of +15bps and secondary performance of recent deals suffered. With the negative technicals in the market, the week of March 9th saw only $7.2bn of supply, average concessions increased to +25bps, and some select issues paid as much as +40bps over prevailing secondary spreads to access the market.
Vicious Cycle Blows Out Secondary Spreads
Little did we know, +40 would represent a “good” execution when compared to the following week of March 16th. As Blue-Chip Tier 1 issuers started to face the reality of both the market and the pandemic, C-Suite/Board’s shifted to a more defensive stance and looked to build cash reserves. Whether it was to refinance CP, keep revolvers fresh, prefund maturities/acquisitions, or simply increase cash reserves, new issue market exploded as issuer’s goals shifted from “price” to “access” and size. Despite still being in the midst of broader volatility, and IG credit spreads moving +25bps, or more, wider per day, we saw Verizon, ExxonMobil and PepsiCo, amongst others, price multi-tranche/multi-billion dollar transactions with some select concessions as wide as +45-65bps, for a total of $27bn+. Other Fortune 500 names followed suit on Thursday and Friday (Disney, UPS, Northrop Grumman, Coca-Cola, Intel) bringing an additional $35bn+ of supply to market at even wider average concessions.
It was a vicious cycle, as each day reset secondary spreads wider, and in turn, new issue premiums higher. In addition to the ~$63bn of supply, secondary spreads were under even more pressure as Lipper reported $35bn+ of cash out-flows from IG credit funds.
This was almost 5x the previous record of $7.3bn, which was set the previous week. Given the technical imbalance of over $47bn of outflows from the previous four weeks and $63bn of new issuance, most of the new deals underperformed to close the week, setting up a dismal forecast for future issuance.
The Fed Steps In
However, all of that changed when the Fed announced three new programs before the opening of trading on Monday, March 23rd. Two of the programs specifically focused on IG bonds, and with the expectation of adding up to $200bn of liquidity to term credit markets:
- Primary Market Corporate Credit Facility (“PMCCF”): Focuses on US domiciled, Investment Grade issuers, offering 4 year and shorter money, under fairly flexible terms (callable anytime, pay interest in kind for up to six months, fixed or floating).
- Secondary Market Corporate Credit Facility (“SMCCF”): Focuses on the outstanding bonds 5yrs and shorter, also of US domiciled issuers.
While the details of both programs are not set, their announcement, and the expectation of the $2tn stimulus package, had the desired effect and investor sentiment shifted.
Monday’s ~$20bn of deals included transactions from General Dynamics and Proctor and Gamble. While average over-subscriptions remained elevated at approximately at 52bps, some green shoots emerged, with the before-mentioned issuers paying substantially less than the average concession and over-subscription levels beginning to increase over to almost 4.5x (the average -in normal times is slightly more than 3x).
Tuesday and Wednesday saw $20bn and ~$25bn of issuance respectively, with lower concessions of +20bps and +10bps, respectively. The week’s apex came on Thursday when $35bn hit the market. New issue premiums fell to an average of +6.6bps (which felt almost normal), subscriptions remained extremely elevated at 6.5x, and dealers were able to move prices from start to finish by -47bps on average.
To close the week, we saw a robust Friday with over $12bn of issuance, though premiums and subscriptions were affected by another record of IG outflows, reported Thursday afternoon, of $38bn. Though spreads were elevated, premiums higher, and money continued to flow out of IG funds, IG investors absorbed enough paper to set all-time issuance records for a week, a month, and a quarter, leaving year-to-date supply 42% ahead of the pace set in 2019.
Over the weekend, the nation was faced with more negative news. The number of cases of COVID-19 jumped, and sadly, the number of deaths. Additional quarantines were put in place as new cities and states try to slow the spread, signifying that the end is still far from over. We await the open, looking to see how the market digests this weekend’s news on top of the $85bn of IG outflows of the past four weeks. Was it simply a tired Friday at the end of an epic run of new issue supply? Or was it the beginning of a reversal back to higher spreads and premiums? Will the pace continue?