Hot US bond market lures investors to re-think risk

Sept 14 (IFR) - US bonds have become so red-hot that investors are buying into some of the riskiest sectors in the high-grade market, including names they refused to look at just a few months ago.

European banks, which could barely give away their bonds to US investors earlier this year, now can't get the same investors to let those bonds go -- as the Royal Bank of Scotland is discovering.

RBS this month announced a tender for nine of its US-dollar bonds worth USD13.25bn, as part of an overall GBP16.6bn liability management buyback scheme.

But it's been tough to get bondholders to give up what now look like high-coupon bonds - or to do so at a time when demand in the US bond market is just about insatiable.

The market is so hot that, even with the RBS tender in effect until Friday, the bank's holding company sold USD2bn of new three-year notes this week - the first Yankee issue from RBS in 18 months.

And even though the deal came to market on Tuesday, just a day after the single biggest volume day ever (almost USD19bn), RBS still attracted USD5.5bn of demand after whispering 250bp.

The new issue priced 25bp tighter at 225bp, and then tightened another 25bp-30bp in the secondary market the following day.

While investors have been shaking their heads in disbelief as they watch spreads scream in across the market, they nevertheless keep piling in for more.

As of Thursday, not one of the USD61bn of bonds sold since August have performed badly in the secondary market.

"We are seeing a melt-up," said David Knutson, senior financials analyst at Legal & General Investment Management America.

"Many of the more conservative investors have been underweight risk, and some ignored the first move tighter," Knutson said.

"But the rally has just kept going, and now I sense the market is capitulating - and far less discerning about what they are buying."

MORE MORE MORE

The biggest scramble for bonds is in the triple-B space, or anything with enough spread to ensure the rally will continue to drive it tighter.

"Triple-B issuers that have spreads north of 200 basis points still have room to tighten," said Anne Daley, managing director in Americas investment grade syndicate at Barclays.

"Conversely, most single-A issuers are already trading at tight levels, and therefore by definition have less room for further tightening. As a result, we've seen triple-B deals pricing with zero to negative concessions, while single-As are paying approximately 5 to 10 basis points in order to offer some price performance on the break."

Triple-B rated Computer Sciences Corp this week compiled a staggering USD5.5bn order book for just USD700m of bonds split evenly into USD350m tranches of three and 10-year notes.

The 10-year portion priced at 280bp, 50bp tighter than its comparables and 70bp tighter than initial thoughts. It then traded another 15bp tighter to 265bp.

"Underwriters are being responsible in the way they allocate and price deals, so that there's at least a basis point or two of tightening in the secondary market," said Jonny Fine, head of US investment grade debt syndicate at Goldman Sachs.

"That has led to a virtuous cycle, where demand remains robust, which enables more deals to come to market."

Demand has been so strong, in fact, that the subsequent tightening in spreads has outpaced the back-up in Treasury yields.

"High-grade bond yields have actually declined, as spread tightening has worked to offset the increase in rates," said Hans Mikkelsen, a senior credit strategist at Bank of America Merrill Lynch.

"It appears that the acceleration in inflows to high-grade funds comes from investors (in Treasuries) getting more comfortable with risk and moving to preserve their principal against rising rates."

And investor demand looks set to only get bigger.

Some bankers expect September to exceed the forecasts for USD100bn in new issues, especially now that European fears have subsided and the Fed has announced new monetary easing.

"Sentiment right now is extremely positive and the Fed action will just continue to fuel that feeling," said one banker.

A large redemption month in October will add to the cash pile - and Yankee and US corporates will be anxious to make hay before the fiscal debate gets underway in the US.

"A lot of issuers are looking to access the market during this period of relative calm in Europe and before any volatility around the US election," said Jim Glascott, head of global debt capital markets at Barclays.

"They realize that the risk is asymmetric - there is more downside than upside to waiting."

VALUING DIVERSITY

The drive to diversify sources of funding will continue to push up corporate Yankee issuance.

So far this year about USD140bn of Yankee corporate bonds have been issued, representing 23% of total supply, compared with USD68bn, or 11% of supply, in the same period last year.

Meanwhile US and Yankee bank deals have been dwindling. So far in 2012 Yankee bank issuance is just USD83bn or 14% of total supply, down from USD133bn (22%) in the same period last year and USD162bn (29%) in 2010, according to Barclays.

Issuance from US financial institutions has dropped to USD218bn year-to-date, from USD304bn the same time last year.

The reduced supply, and being the sector choice for high-beta in a rallying market, has pushed spreads on the financials sub sector of the Barclays investment grade index down to 162bp, compared with 177bp at the end of August and 233bp at the beginning of the year.

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