Last week we wrote on the opportunistic behavior of municipal borrowers that have used the decline in rates this year to refinance outstanding tax-exempt bonds by issuing taxable bonds, and still saving money (http://www.snwam.com/insights/2019/9/16/muni-bond-supply-moves-higher-but-not-how-you-would-think). This week we felt compelled to stay on that theme, but highlight an interesting development in the corporate market.
September has been a robust month for corporate bond issuance. Supported by steady fund flows into corporate bond mutual funds, borrowers returned from Labor Day vacations ready to issue. Month-to-date September 20, 2019, investment grade corporate bond issuance has totaled $140B with another $20B on tap for this week. This will bring us just shy of the monthly record of $177B*.
And not only are corporations taking advantage of the decline in rates broadly, they are using the shape of the yield curve to their advantage. Because the difference in short-term and long-term bond yields has closed (i.e. flat yield curve), corporations are terming-out their debt. This can be seen in the average duration of corporate bond indexes, which are constructed using bonds outstanding in the marketplace. For example, the effective duration of the ICE/BAML U.S. Corporate Bond Index has moved from a low of 6.9 years in January to 7.5 years as of this month.
This duration extension highlights two key observations:
1. While the amount of outstanding corporate debt has risen steadily over the last several years, and there is a higher percentage of BBB-rated corporate bonds than ever, corporations are in a decent position fundamentally. The amount of cash generated to cover interest payments has remained steady and debt coming due has been moved well into the future, reducing a liquidity crunch should the economy weaken.
2. Corporate bond spreads are not as attractive when comparing them versus historical periods. Typically, the difference between corporate yields and treasury yields is higher for longer maturities, which reflects the uncertainty of ever-changing corporate prospects. While credit spreads today appear to be generally in-line with post financial crisis historical averages, when we analyze duration adjusted credit spreads, the market seems a bit rich.
In general, decent fundamentals but rich valuations are not causing us to be overly aggressive in our corporate positioning across our strategies. The corporates that we do own are typically of short-maturities with attractive income generation, or longer-maturities in highly rated companies.
Source: *Bloomberg, ICE/BAML Indices