High-grade: Tobacco bond spreads gap wider as regulators eye menthol ban

Credit spreads referencing tobacco concerns gapped wider this morning as the U.S. bond markets reopened, as investors react to market speculation that the U.S. Food and Drug Administration (FDA) may propose a ban on the use of menthol cigarettes in the days to come, building on its 2009 ban of other-flavored cigarettes “known to appeal to youth and young adults.”

Bonds backing British American Tobacco (BATSLN) were tagged with week-to-week moves as much as 30–40 bps wider. BAT Capital 3.557% notes due 2027, which were priced last August at T+130, traded today at T+175–180, from T+145–150 a week ago, and T+135 in early August, trade data show. The issuer’s 4.54% bonds due 2047, which it placed last summer at T+170, traded today at T+230, from T+190–195 last week, and T+175 in early August.

BAT printed both bond issues as part of a blockbuster, $17.25 billion offering across eight tranches backing its acquisition of the 57.8% of Reynolds American that it did not already own for roughly $49.4 billion.

S&P Global Ratings in May noted that the acquisition of the Newport brand gave the company “the No. 1 position in menthol cigarettes, a growing category in a declining market.”

Five-year BAT protection costs in CDS are near 100 bps this morning, from 77 bps a week earlier, and 67 bps in early August. Analysts today noted that BAT is particularly exposed to menthol regulatory risk, as it derives more than one-fifth of its overall operating profit from U.S. menthol, slightly more than Altria and roughly double that of Imperial Brands.

Altria five-year CDS this morning lurched higher by 18% to test 45 bps, from 36 bps last week. Imperial CDS neared 90 bps, from 77 bps last week.

The FDA reports that 19.7 million people in the U.S. are current smokers of menthol cigarettes, and that “youth who smoke are more likely to smoke menthol cigarettes than older smokers.” It said more than half of smokers aged 12–17 smoke menthols.

The FDA’s promotion of menthol awareness comes as it also plans a public hearing on Dec. 5 to discuss its efforts to “eliminate youth e-cigarette use.” The agency last summer announced a plan that it says provides a “multi-year roadmap” to achieving its goal of lowering nicotine in cigarettes to “non-addictive levels,” while also addressing “known public health risks” associated with electronic nicotine delivery systems (ENDS). Spread moves across the sector’s bond stacks were modest at the time, as investors eyed the many caveats that might shelter producers from immediate operational strains.

In an analyst briefing in October, BAT detailed its intensifying outreach to the FDA to manage regulatory risk, citing 16 “engagements” with the body since 2016, versus 12 in 2009–2015. It downplayed the risk that regulation would be a negative for the industry and BAT, arguing that “the process is evidence based, complex and will take a long time.” It noted that the rule-making process has as many as nine steps, and that just the preparation of a proposed rule can drag on for years.

External analysts today noted that the industry likely would flood the courts to mitigate any impact, potentially protracting the implementation of any material regulation. — John Atkins

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Fridson – Fallen-Angel Watch: How Will Triple-B Downgrades Affect the High-Yield Market?

Synopsis: Based on our analysis of past surges in fallen-angel supply, we expect that the future spread-widening directly attributable to large-scale downgrading of present BBB bonds, if it occurs, will be in the range of 50–60 bps.

There is a specter haunting the high-yield market…the specter of BBB downgrades.

Over the past five years, the face value of the ICE BofAML US Corporate BBB Index increased by 65%. By contrast, the spend-like-a-sailor U.S. government debt, as measured by the ICE BofAML US Treasury Index, grew by “only” 24% over the same period. Not only the quantity, but the quality of bottom-tier investment-grade bonds has raised concerns, including the possibility of a spillover to high-yield that might create a supply problem:

More broadly, the question is how high the Fed can raise rates before companies struggle to service their cost of debt and whether companies in the triple B segment will be downgraded to junk after piling on leverage in deals. When that happens, higher-quality and less-leveraged companies will probably benefit—but at that point, equity markets and other risky securities might start to struggle as well, which would hurt investors’ ability to earn returns (see note 1). (Boldfacing added.)

To keep this problem in perspective, large-scale downgrading of BBBs will almost certainly improve the high-yield universe’s ratings mix. Most issues will probably fall from the BBB to the BB tier. Few if any will go directly from BBB to the below-speculative-grade-median CCC tier.

More to the point, though, would not the dumping of tens of billions of dollars of IG bonds into the HY universe depress HY prices, based on simple principles of supply and demand? In reality, there is nothing simple about supply and demand when it comes to the high-yield market. For example, the financial press sounds alarms from time to time about the buildup of the high-yield calendar, warning that the new supply will crush prices of outstanding issues. The actual state of affairs at such junctures is that CFOs of high-yield companies that will need to finance at some point are collectively responding to a price signal that speculative-grade spreads are inordinately narrow, making it extremely attractive to issue. Seeing the forward calendar build up, portfolio managers stop chasing after secondary paper trading at ridiculous levels. Spreads consequently widen to a more realistic risk-reward tradeoff and many deals quietly disappear from the calendar. After all, they merely represented opportunistic financing plans by companies with well-managed maturity schedules and no urgent need to come to market. The frequently ballyhooed crushing of prices by new-issue supply has never happened, except under highly unusual conditions in the late 1980s (see note 2).

In contrast to new issuance activity that is sensitive to market conditions, fallen angels enter the high-yield universe whether or not investors are receptive to incremental supply. Even in this case, however, the impact is not as simple as, “more supply, same amount of dollars invested, prices fall proportionately.” For one thing, the investment rules under which IG portfolio managers generally operate are not as inflexible as media accounts sometimes suggest. That is, they are not typically forced to sell a bond the instant it falls below Baa3/BBB–. Institutional investors recognize that enforcing such a rule would be counterproductive, as it would mandate fire sales. Furthermore, a great deal of paper that falls to speculative-grade stays in the general accounts of life insurance companies, which are not required to sell unless the obligations become impaired or they bump up against regulatory limits based on the overall ratings mix of their portfolios. Non-mandatory selling of fallen angels reduces a life insurer’s regulatory surplus, in turn restricting its ability to generate additional premium income by writing new policies.

Owing to such nuances, investors should carefully scrutinize any attempt by analysts to quantify the expected impact of future downgrading of BBB bonds. A good principle to follow is to put limited faith in the power of predictions absent a persuasive explanation of the past. The key challenge in measuring the impact of past fallen-angel-driven supply surges is the presence of confounding factors. That is to say, many other events are causing spreads to move at the same time that investment-grade bonds are dropping to speculative-grade in large numbers. Sorting out the influences of all those events is no simple task.

To isolate the impact of a substantial increase in fallen-angel supply, we employ the FridsonVision Fair Value Model (see note 3)—with an important modification—to estimate what the ICE BofAML US High Yield Index’s option-adjusted spread (OAS) should have been prior to and following the supply surge. The fair value model’s explanatory variables are the factors that explain variance in the OAS over time. If the spread is at fair value prior to the surge and wider than fair value following the surge, and if nothing else out of the ordinary has occurred in the interim, then in principle the disparity between fair value and the post-surge actual spread represents the impact of the surge. As we shall see, the facts on the ground are somewhat messier.

The modification that we make in our model is to add the Chicago Board Options Exchange S&P500 Volatility Index, or VIX, as an explanatory variable. This change increases the model’s percentage-of-variance-explained (R2) from 80% to 91%. The question naturally arises, why do we not include VIX in our standard model? That is because we regard VIX, popularly known as the “fear gauge,” as the non-fundamental, i.e., emotional component of high-yield pricing. It is precisely when the spread is inflated because of emotional factors, rather than true credit ones, that value-oriented investors should step up their high-yield allocations. A very high R2 produced by inclusion of VIX will tend to suppress such BUY signals. For the present exercise, however, we want to include among our explanatory variables all factors other than supply, at least to the extent feasible. Ideally, this method will leave the supply surge as the sole explanation of any observed gap between actual OAS and fair value.

Case Study #1—2016 energy price plunge
We begin our analysis with a recent case of a surge in high-yield supply driven by fallen angels. Between Dec. 31, 2015 and Feb. 29, 2016 the face value of the ICE BofAML US Fallen Angel High Yield Index rose by $34.4 billion, an increase of 21.2%. That represented the eighth largest two-month increase out of 255 months of the fallen-angel index’s available history, excluding two observations that were affected by the index operator’s June 2002 initial inclusion of Rule 144a issues in its high-yield indexes. We selected a two-month interval because in this case, the non-fallen-angel component of the ICE BofAML US High Yield Index (the ICE BofAML US Original Issue High Yield Index) barely budged over the period (–0.3% change in face value). Consequently, the $34.4 billion increase in the fallen-angels component accounted for more than 100% of the $30.5 billion increase in the overall high-yield index’s rise in face value. Selecting this period, therefore, eliminates the possible confounding factor of increased supply that was unrelated to downgrading of investment-grade debt to speculative-grade debt, the phenomenon for which we seek to quantify the impact.

The $34.4 billion growth of the fallen angels’ face amount during 2016’s first two months was driven primarily by downgrades of Energy issues. Over that span the face amount of the ICE BAML Fallen Angel Index’s Energy segment increased by $22.0 billion. The large migration of investment-grade Energy issues coincided with a low point in oil prices. The Generic US Crude Oil, West Texas Intermediate contract, which had been declining steadily from a high of $107.26/barrel on June 20, 2014, bottomed out at $26.21 on Feb. 11, 2016.

According to our Fair Value Model, enhanced by VIX, the predicted OAS for the ICE BAML High Yield Index on Feb. 29, 2016 was 699 bps. The actual OAS on that date was 775 bps. On the face of it, the surge of fallen-angel supply caused the high-yield spread to be 76 bps wider than it should have been. That amount compares with a standard deviation of 83 bps for the Fair Value with VIX Model, implying that the impact of the new fallen-angel supply was not inconsequential.

There is a possible flaw in this interpretation, however. To begin with, the Fair Value with VIX Model indicates that at the beginning of our two-month analytical window, prior to the fallen-angel surge, the ICE BofAML High Yield Index was 67 bps wider than fair value (695 bps actual spread minus 628 bps predicted). If the same factors not captured by the model were influencing spreads in both periods, then one could argue that the supply surge caused the high-yield spread to widen by a negligible nine basis points (76 bps minus 67 bps).

One obvious candidate for a factor not captured by the model is the widening of spreads on Energy bonds themselves as a function of the further drop in crude-oil prices during this case study’s observation period. Pursuing that thought, we find that on Dec. 31, 2015 the Energy component accounted for 10.92% of the ICE BAML High Yield Index’s market value and was already quoted at a distressed weighted average OAS of 1,415 bps. Two months later, the comparable figures were 11.06% and 1,609 bps. Based on those figures and the ICE BAML High Yield Index’s spreads of 695 and 775 bps on the two dates, representing a widening of 80 bps over the period, we calculate that the non-Energy component widened by 64 bps (from 607 bps to 671 bps) over the period.

This means that widening of the Energy component, a calculation affected by the addition of the fallen angels between the two dates, accounted for just 20% (16 bps out of 80 bps) of the spread-widening on the ICE BAML High Yield Index. Other factors not captured by our model, whatever they may have been, had a bigger impact. The interpretation most generous to analysts who warn of a major jolt from BBB downgrades is that the sole non-model-captured factor in place on Feb. 29, 2016, other than the impact of the spread-widening on Energy issues, was the separate (albeit also driven largely by the Energy industry’s woes) effect of the increase in fallen-angel supply. In short, we can regard 76 bps – 16 bps = 60 bps as the upper bound of OAS impact on the high-yield spread in the early 2016 oil price plunge. The lower bound is nine basis points, calculated above.

Case Study #2—2005 General Motors downgrade 
Our second case study involves the largest two-month percentage increase in face value of the ICE BAML Fallen Angel Index since its Dec. 31, 1996 inception, other than the index’s previously mentioned mid-2002 first-time augmentation with Rule 144a issues. The fallen-angel index’s face value increased by $43.4 billion, or 31.21%, from March 31 to May 31, 2005. That net increase was more than fully accounted for by the entry of $45.5 billion face amount of bonds of General Motors (GM) and its captive finance subsidiary General Motors Acceptance Corporation (GMAC), both of which fell to a Composite Rating of BB1. Furthermore, the $43.4 billion of fallen-angel debt added to the ICE BAML High Yield Index during the period more than fully accounted for the $42.5 billion (a 7.11% increase) growth in that index’s face value. As in the previous case study, we can attribute any impact of supply-driven spread impact we find to downgrades from investment-grade, as opposed to new issuance.

On May 31, 2005 the Fair Value with VIX Model predicted an OAS of 274 bps for the ICE BAML High Yield Index. The actual OAS on that date was 413 bps. By subtraction, the simplest explanation is that the huge influx of fallen-angel supply caused the high-yield spread to be 139 bps wider than it otherwise would have been.

As in the previous case study, however, we find that at the base date high-yield bonds were considerably cheaper than our model predicted. On March 31, 2005 our fair value estimate was 271 bps versus an actual spread of 352 bps, a disparity of 81 bps.

If we assume that the same non-model-captured factors that caused the ICE BAML High Yield Index to be 81 bps wider on March 31, 2005 were in place two months later, we then calculate the impact of the entry of GM/GMAC fallen angels as 139 bps – 81 bps = 58 bps. Mimicking the analysis presented in our first case study, we also isolated the spread impact of the GM/GMAC bonds themselves, as distinct from their impact on supply. On March 31, 2005 the GM/GMAC bonds were not in the ICE BAML High Yield Index, so their widening from that date does not affect our calculations. On May 31, 2005 they represented 6.16% of the ICE BAML High Yield Index’s market value and had a weighted average OAS of 533 bps. Based on these numbers we calculate an OAS of 405 bps for the non-GM/GMAC component, not very different from the ICE BAML High Yield Index’s 413 on the same date. Subtracting the difference of eight basis points from the 58 bps calculated just above, we put the lower bound of the GM/GMAC downgrading impact at 50 bps. The upper bound is the raw 139 bps calculated above.

Predicting the impact on high-yield spreads of the large-scale downgrading of BBB bonds that some analysts expect is no simple task, given other factors that will act concurrently on spreads. To be credible, any such prediction must be based on a methodology that provides plausible estimates of past surges of fallen-angel supply. Our judgment, based on analysis of two very big surges of the past, is that the likely spread-widening that will be directly attributable to a major downgrading of BBBs—if it happens— is in the range of the lower bound of 50 bps in the 2005 GM/GMAC downgrading and the upper bound of 60 bps in the 2016 Energy downgrading. Note that the greatly feared mass downgrading of BBBs may occur in conjunction with other events that cause additional spread widening. This piece focuses solely on the spread-widening that will result directly and exclusively from a swelling of fallen-angel supply.

David Sherman, President of Cohanzick Management LLC, suggested the topic addressed in this piece. 

Marty Fridson, Chief Investment Officer of Lehmann Livian Fridson Advisors LLC, is a contributing analyst to S&P Global Market Intelligence. His weekly leveraged finance commentary appears exclusively on LCD, an offering of S&P Global Market Intelligence. Marty can be reached at [email protected]

Research assistance by Kai Zhao and Shuo Li.

ICE BofAML Index System data is used by permission. Copyright © 2018 ICE Data Services. The use of the above in no way implies that ICE Data Services or any of its affiliates endorses the views or interpretation or the use of such information or acts as any endorsement of Lehmann, Livian, Fridson Advisors, LLC’s use of such information. The information is provided “as is” and none of ICE Data Services or any of its affiliates warrants the accuracy or completeness of the information.

1. Alexandra Scaggs, “Can US triple C-rated bonds stay ahead of the pack? High-yield debt is looking vulnerable after strong outperformance in the first half.” Financial Times (July 4, 2018).

2. In the late 1980s, dominant underwriter Drexel Burnham Lambert’s rivals “improved” upon that firm’s innovation, the highly confident letter. This was a device that enabled bidders in takeover battles to represent that the financing for their bids was effectively assured. Drexel’s competitors provided bridge loans, booked on their own balance sheets, to the bidders they backed. These bridge loans were often made to overleveraged and deteriorating credits, creating an urgency for them to be replaced by permanent financing, i.e., bonds. The investment banks that saddled themselves with the “burning bridges” therefore faced extreme pressure to float high-yield bonds, regardless of prevailing market conditions. The market-wrecking consequences of desperation-driven offering was compounded by the fact that investors were smart enough to shun the obvious Chapter 11 candidates. Some major investment banks were nearly bankrupted by these imprudent transactions. The silver lining was that they learned from their near-death experiences, with the result that since that time high-yield investors have not seen spreads blow out as a consequence of forced offerings.

3. For details of our Fair Value methodology see “Fair Value update and methodology review” (LCD News, Jan. 24, 2018). In our model, the factors that explain variance in the high-yield spread over time are credit availability, selected economic indicators, the current default rate (a minor factor), Treasury yields, and a dummy variable representing the era of quantitative easing by the Fed.

Are you press, and would like more info on this analysis? Contact Tahmina Mannan or Farhan Husain.

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Default Protection on Whirlpool Debt Hits 2-year High as Costs, Tariffs Bite

whirlpoolThe cost of buying protection on the debt of Whirlpool yesterday tested the highest readings since the shock Brexit vote late in June 2016, after the appliance maker detailed a difficult second quarter on rising raw material input costs, transportation setbacks, and uncertainty regarding the emerging tariff regime.

Five-year CDS referencing Whirlpool debt increased nearly 15% yesterday morning, with bids at 95 bps, from 83 bps at the start of this week, according to Markit. Costs haven’t held north of 100 bps since the oil-rout days of 2016’s first quarter, and readings were below 50 bps as recently as late January, when President Trump’s initial tariff impositions appeared narrowly tailored to specific products, including imported washers.

Whirlpool today revealed a material $50–100 million increase in its raw-material cost assumptions for the year, now putting the year-to-year increase at roughly $350 million. The company noted some protections against rising steel cost inputs from contract hedging, but lamented its inability to hedge mounting costs for critical resins as oil prices trend higher. It also warned that freight costs were a freshening headwind amid higher fuel costs and an imbalance between heated demand and the more limited availability of freight carriers.

While the company is still positive on the medium- to long-term benefits of tax reform to consumer demand and corporate competitiveness, it also said it was beginning to feel the pinch of tariffs, either as a direct importer or via its suppliers, adding to the weight of cost inflation. Its efforts to cull running costs from its structure helped bolster EBIT margins through a rough patch in its European operations and a steeper-than-expected 4% decline in consolidated 2Q revenue, but Whirlpool now faces a tightrope exercise in attempting to pass through its higher production costs to consumers amid crosscurrents in global macro demand.

“Since mid-May, a number of elements in the macro environment worsened significantly. In addition to continued raw material inflation, we experienced a temporary but significant decline in U.S. industry demand, headwinds related to the U.S. tariff as well as the Brazilian trucker strike and currency fluctuations in Russia and Latin America,” CEO Marc Bitzer said on today’s call with analysts. “In Europe, we were unable to overcome macro headwinds due to slower progress when expected as we work to recover volumes in the region.”

He went on to note the expected benefit to free cash flow from leaner inventories, strong product mix trends, working capital optimization, and reduced structural costs. Still, the projection for free cash flow of roughly 4% of net sales for all of 2018 is shy of the company’s stated long-term goal of 5–6% and a downshift from projections at the start of the year.

On the liquidity front, Whirlpool on April 24 announced the sale of its Embraco subsidiary to Japan’s Nidec for roughly $1.1 billion, the proceeds of which backed a $1 billion share repurchase via tender offer. The company said today that it would continue to buy back shares under its remaining $950 million authorization.

Whirlpool during the quarter also entered into a term loan agreement via a Wells Fargo–led lender group, providing for an aggregate lender commitment of €600 million (roughly $703 million) which was earmarked for general corporate purposes, including the repayment of commercial paper. — John Atkins

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Hi-Grade: McDonald’s launches $1.5B Bond Offering into Heavy, Post-CVS Market

mcdonaldsWhile tough marketing conditions this week have sidelined many prospective issuers, McDonald’s Corp. today launched a $1.5 billion, three-part offering, after inking a similar structure one year ago. The new offering was split evenly across $500 million each of five-year notes due April 1, 2023 at T+75, 10-year notes due April 1, 2028 at T+100, and a tap of the existing 4.45% notes due March 1, 2047 at T+140, sources said. Launch levels imply reoffer yields of roughly 3.35%, 3.81%, and 4.46%, respectively.

McDonald’s launched the deal at the firm end of guidance (which was set in the areas, plus or minus five basis points, of T+80, T+105 and T+145), and 15–20 bps through early whispers. Even so, McDonald’s appears on track to pay 5–10 bps of new-issue concession to clear today’s offering in heavy markets.

The 4.45% 2047 tap is projected to be placed at a yield close to the coupon rate. The deal was originally printed in March 2017 as a $550 million offering at T+137, or 4.48%. The issue traded earlier today at a G-spread of 142 bps, or roughly 10 bps higher than levels on Monday, according to MarketAxess.

That 30-year tranche was part of a $2 billion, three-part deal that also included 2.625% five-year notes due January 2022 at T+62, or 2.639%, and 3.5% 10-year notes due March 2027 at T+107, or 3.562%. For reference, the 2022 issue changed hands this morning G-spreads from 58–60 bps, before accounting for roughly six basis points on the curve, and the 2027 notes traded last week at G-spreads in the area of 86 bps, and roughly three basis points wider today, trade data show.

Cautious marketing of the new bonds follows on a staggering $64.2 billion of high-grade offerings placed over the five sessions through Monday, including big M&A deals inked by CVS Health last Tuesday ($40 billion, or the third largest corporate offering on record) and Campbell Soup on Monday ($5.3 billion). That rolling sum was less than $5 billion shy of the of the all-time record for any five-day period, or the $68.8 billion placed in the five sessions around a $46 billion M&A-driven behemoth inked by Anheuser-Bush InBev in January 2016, according to LCD.

At the tail end of the latest issuance deluge, borrowers on Monday paid roughly 12 bps in new-issue concessions, on average, rivaling the extra costs witnessed in the immediate aftermath of the shock Brexit vote in June 2016.

Proceeds from today’s offering will be used for general corporate purposes. Of note, the company has $750 million of 2.1% notes coming due on Dec. 7, 2018, followed by $400 million of 5% notes due in February 2019, according to S&P Global Market Intelligence.

In March 2017, the company announced that it would return $22–24 billion of cash to shareholders through 2019. Last July, it announced a new $15 billion share-repurchase program, which does not have a specified expiration date. McDonald’s in 2016 completed an accelerated share-repurchase program and bought back a total of $11.2 billion of its shares over the calendar year. That was up from $6.1 billion in 2015, and is by far the most in the company’s history, according to S&P Global Market Intelligence. Buybacks in 2017 amounted to $4.7 billion.

The Oak Brook, Ill.–based restaurant company’s ratings profile includes stable outlooks on all sides.

In December 2017, Fitch affirmed its BBB rating on the company. “McDonald’s ratings balance its shareholder-friendly financial strategy with its substantial cash flow, significant scale, improved comparable sales (comps), and Fitch’s view that the company will maintain total adjusted debt/EBITDAR in the mid-to-high 3.0x range while generating FCF of about $1 billion or more annually,” analysts said.

S&P Global Ratings maintains a BBB+ rating for the company. “We also believe McDonald’s will moderate share repurchases over the longer term while continuing to work to return revenue growth and customer traffic. We assume the company will maintain leverage of less than 4x, supported by the range of initiatives that began in 2015. Still, the competitive environment is fierce for the quick service restaurant sector overall,” the agency said in ratings rationale published in April 2017. — Gayatri Iyer/ John Atkins

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CVS Eyes Jumbo Hi-Grade Bond Offering to Back $48B Cash Portion of Aetna Buy

CVS Health (NYSE: CVS) has announced the structure for its jumbo benchmark offering of SEC-registered senior notes as an offering in as many as nine parts, as the company seeks debt financing for the roughly $47.9 billion cash portion of the purchase price for its mammoth acquisition of Aetna (NYSE: AET). Based on the remaining bridge financing, the deal is on track to become at least the third largest corporate placement on record, according to LCD.

Early whispers are out in the T+110 area for two-year notes due March 9, 2020 and in the T+120 area for three-year notes due March 9, 2021, and at the LIBOR equivalents for same-dated FRNs for both tenors. Whispers started in the T+140 area for five-year notes due March 9, 2023, the T+160 area for seven-year notes due March 25, 2025, the T+175 area for 10-year notes due March 25, 2028, the T+200 area for 20-year bonds due March 25, 2038, and the T+215 area for 30-year bonds due March 25, 2048.

For reference, the issuer’s 2.875% notes due 2026 traded this morning at T+128, or a G-Spread of 133 bps, and its 5.125% bonds due 2045 traded at T+178. Reflecting the expected new-issue concessions required to clear the blockbuster M&A financing, the outstanding notes are 30–40 bps wider since the end of January, after speculation mounted that CVS would tap the bond markets sooner than later. The issuer’s 3.5% notes due July 2022 traded this week at T+100 and its 4% notes due December 2023 at T+122, both roughly 25–30 bps wider since the end of January.

The company last week tapped active bookrunners Barclays, BAML, Goldman Sachs, and J.P. Morgan to arrange fixed-income calls on Friday, March 2, and Monday, March 5. Wells Fargo is passive bookrunner.

All but the 30-year tranche of today’s offering are subject to a special mandatory redemption, at 101, in the event the merger does not close by Sept. 3, 2019. The merger was slated to close in the second half of this year, pending regulatory approvals. The issues are all subject to make-whole call provisions, and the 2023–2048 issues carry standard tenor-specific par calls prior to maturity. All tranches are subject to change-of-control put provisions.

The $77 billion price tag for the Aetna play includes the assumption of roughly $9 billion of Aetna debt. The bond effort comes after CVS in December obtained a $5 billion unsecured A term loan from a group of 20 banks backing the M&A play. Barclays, Goldman Sachs, Bank of America Merrill Lynch, J.P. Morgan, and Wells Fargo acted as joint lead arrangers. Barclays is administrative agent. As a result of the term loan agreement, the size of the $49 billion M&A bridge facility was reduced by $5 billion.

In terms of the biggest corporate offerings on record, the top spots are held by Verizon, which placed $49 billion of notes in September 2013 to round out its ownership of Verizon Wireless, and Anheuser-Busch InBev, which printed a $46 billion trade in January 2016 for its SABMiller buy. AT&T last July placed the third-largest deal at present, with a $22.5 billion offering to support its bid for Time Warner. Actavis Funding inked $21 billion in March 2015 for its Allergan acquisition, and Dell/EMC placed $20 billion of notes in May 2016.

CVS’ own $15 billion offering in July 2015—to back its acquisitions of Omnicom and Target’s pharmacy business—is among the 20 largest corporate deals on record.

Five-year CDS referencing CVS debt was indicated at 68 bps this week, roughly in line with indications around the time of the CVS/Aetna M&A announcement in early December last year, and up from an interim low of 58 bps at the start of 2018, according to Markit.

The present BBB+/Baa1 ratings on CVS are under review for downgrade. Aetna’s A grade at S&P Global is under review for downgrade, while Moody’s on Dec. 4 affirmed its lower Baa2 rating and stable outlook on Aetna.

CVS last week disclosed a financial update related to the Aetna transaction, and noted glowing press characterizations of its performance this week before the House Subcommittee on Regulatory Reform, Commercial and Antitrust Law.

“We believe that this transaction, through better pharmacy care and coordination with primary care professionals, can make a significant dent in reducing health care costs,” CVS general counsel Thomas Moriarty told the committee. “Put simply, to make real progress on behalf of consumers, and the health care system, we have to break the current logjam.” — John Atkins

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HG Bonds: Occidental Petroleum Shops $1B Deal to Refi Debt Maturity

Following a recent debt maturity, Occidental Petroleum (NYSE: OXY) is shopping $1 billion of SEC-registered, 30-year senior bonds due March 15, 2048, with early whispers out in the T+120 area to initially suggest a reoffer yield near 4.35%, sources said. Bookrunners for the A/A3/A offering are Barclays, J.P. Morgan, and Wells Fargo.

The offering is the first for the issuer since Nov. 2, 2016, when it placed a $1.5 billion, two-part offering, across $750 million each of 3% notes due Feb. 15, 2027 at T+125, and 4.1% notes due Feb. 15, 2047 at T+155. The 4.1% 2047 issue changed hands last week near T+100, trade data show.

Proceeds of today’s “no-grow” offering will be used to refinance the repayment of the issuer’s $500 million aggregate principal amount of 1.50% senior notes due 2018 that matured on February 15, 2018, and for general corporate purposes, according to regulatory filings.

The issue is subject to a make-whole call provision and a par call from six months prior to maturity.

The single-A ratings profile reflects stable outlooks at S&P Global Ratings and Moody’s, and a negative outlook at Fitch. The Fitch outlook dates to a downward revision last July, and reflects “concerns about the impact of the company’s large dividend ($2.3 billion), which Fitch anticipates will result in prolonged negative FCF over the next few years, and above average execution risk in getting back to FCF neutrality, which is less typical for ‘A’ rated entities.”

Fitch also cited “moderate increases in OXY’s gross debt levels since the downturn began (rising from around $6.8 billion in 2014 to $9.9 billion at YE 2016), and the recent move by Saudi Arabia and allies UAE, Egypt, and Bahrain, to cut diplomatic and transport ties with Qatar, which has increased political risk surrounding OXY’s Qatari production.”

S&P Global Ratings last week noted in ratings rationale that, which the dividend is “sizable,” overall financial policy at the company is “modest,” supporting a view that financial measures would “remain strong, albeit significantly weaker than historical levels, with average funds from operations (FFO) to debt in excess of 60% and debt to EBITDAX below 1.5x.”

For reference, Occidental paid out roughly $2.4 billion in dividends last year, the most in its history after a steady increase from $1.6 billion in 2013, and less than $1 billion in 2008.

Houston-based Occidental Petroleum, together with its subsidiaries, engages in the acquisition, exploration, and development of oil and gas properties in the United States and internationally, via its Oil and Gas, Chemical, and Midstream and Marketing segments. — John Atkins

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HG Bonds: Boeing Shops $1.4B, Four-Part Deal Ahead of Two Maturities

Boeing Co. (NYSE: BA) is in the market today with a $1.4 billion, four-part public offering across five-year notes due 2023, a 10-year issue due 2028, a 20-year tranche due 2038, and 30-year notes due 2048, all with a March 1 maturity date, sources said. The “no-grow” issue is guided to an A/A2/A profile.

Goldman Sachs is a bookrunner across all the tranches. Additionally, Citigroup and J.P. Morgan are marketing the 2023 issue, Barclays and BAML are bookrunners for the 2028 notes, SMBC and Wells Fargo are bookrunners for the 2038 tranche, and Deutsche Bank and Mizuho are marketing the long bonds.

The deal will carry make-whole call provisions and par calls from one and three months prior to maturity for the five- and 10-year notes, and from six months prior to maturity for the 20- and 30-year notes.

According to regulatory filings, the proceeds from today’s offering will be used for general corporate purposes. Of note, Boeing has two long-term maturities due this year, starting with $350 million of 0.95% notes due on May 15, followed by $250 million of 2.9% notes due Aug. 15, which was issued by subsidiary Boeing Capital Corp., according to S&P Global Market Intelligence.

Initial whispers for today’s proposed offering surfaced at T+55–60 for the 2023 notes, at T+75–80 for the 2028 issue, in the T+85 area for the 2038 notes, and at T+100–105 for the long bonds, indicating reoffer yields near 3.20%, 3.64%, 4%, and 4.15%, based on the tight end of talk.

The Chicago-based company last tapped the market a year ago, when it placed a $900 million, three-part offering, evenly split across 2.125% five-year notes due March 2022 at T+42, or 2.38%; 2.8% 10-year notes due March 2027 at T+60, or 3.07%; and 3.65% 30-year notes due March 2047 at T+85, or 3.91%. For reference, the 2022 issue traded yesterday at T+18 (or at a G-spread equivalent of 30 bps), the 2027 notes changed hands last month at T+49 (at a G-spread of 51 bps), and the 2047 notes traded late last month at T+75 (or at a G-spread of 77 bps), according to MarketAxess.

Since December, Boeing and Brazilian aircraft manufacturer Embraer S.A. have been in discussions about a possible transaction involving a possible merger. According to S&P Global Ratings neither company has specified what form such a deal may take, though it could be a joint venture, a full acquisition of Embraer, or some other deal structure. The government of Brazil maintains a “golden share” in Embraer, which it could use to put pressure on or block the deal.

S&P Global Ratings said Boeing’s ratings will likely not be affected by a possible transaction between the two companies. “We believe that Boeing has flexibility at the current rating to undertake a large multi-billion dollar transaction because the company’s funds from operations (FFO)-to-debt ratio is currently well above our downgrade trigger of 40% (Boeing’s FFO-to-debt ratio was 62% for the 12 months ended Sept. 30, 2017),” the agency, which maintains an A rating and stable outlook, said on Dec. 22, 2017.

“The company currently has about $10 billion in cash and short-term investments and we expect it to generate at least $10 billion of free cash flow over the next 12 months. However, our current forecast assumes that management will use all of the company’s free cash flow and some of its cash on hand for dividends and share repurchases,” analysts added.

Last April, Fitch affirmed its A rating and stable outlook on Boeing. “Large acquisitions, although not anticipated, also could affect the ratings, as could debt-funded share repurchases. Sustained consolidated FFO-adjusted leverage approaching 2.0x could lead to a negative action,” Fitch said at the time. — Gayatri Iyer

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CVS Eyes $45B in New Debt for Aetna Buy

CVS logoBonds backing CVS Health (NYSE: CVS) are leaning wider this morning after the company’s Sunday confirmation of a blockbuster $77 billion, debt-financed deal to merge with Aetna (NYSE: AET), though the bulk of the move wider for bonds took place over the last week in anticipation of the formal M&A announcement, trade data show.

The debt portion of the financing would be among the heftiest ever attempted. CVS today on the M&A call said the company would look to place $45 billion of new debt and draw on cash on hand to finance the merger, which is slated to close in the second half of 2018, pending shareholder and regulatory approvals. The definitive agreement values Aetna shares at roughly $69 billion, and the $77 billion transaction price includes the assumption of Aetna debt. Barclays, Goldman Sachs, and BAML are providing $49 billion of financing commitments, according to CVS.

The biggest single debt offerings on record remain the $49 billion, eight part deal placed by Verizon in September 2013 for its acquisition of Vodafone’s stake in Verizon Wireless, and the $46 billion, seven-part deal placed by Anheuser-Busch InBev in January 2016 for its SABMiller buy. AT&T in July this year placed $22.5 billion of notes, or the third biggest offering on record, and the anchor piece of a $40 billion debt-financing package backing its now-imperiled bid to merge with Time Warner.

CVS, now a decade out from its transformative acquisition of Caremark, in 2015 placed $15 billion of notes backing its $12.7 billion acquisition of Omnicare and $1.9 billion acquisition of Target’s pharmacy and clinic businesses.

CVS 5.125% bonds due July 20, 2045 led the charts for trading volume this morning, changing hands at a weighted average of T+172, from T+170 on Friday and T+161 one week ago. The bonds lurched wider from T+133 after press reports on Oct. 26 tipped the advanced merger talks.

Meantime, Aetna 2.75% notes due 2022 traded this morning at T+88, or only a few basis points wider week to week, but up from trades at T+54 ahead of the revelation of M&A ambitions late last month.

Five-year CDS debt-protection costs actually ebbed this morning by three basis points, to a reading near 65 bps, according to Markit. The close on Friday at 68 bps was the high-water mark since The Wall Street Journal broke the story on Oct. 26, reflecting a move up from 50 bps on Oct. 25. Aetna five-year CDS was steady today near 39 bps, but was up from 26 bps on Oct. 25.

CVS carries BBB+/Baa1 senior ratings at present, while Aetna is rated A/Baa2/A–.

S&P Global Ratings and Moody’s today placed their rating on CVS under review for possible downgrade, but both noted that they expected any cut to be limited to one notch. Both agencies also affirmed their respective Tier 2 short-term commercial paper ratings, on a view that the combined entity would retain strong liquidity and would target rapid deleveraging under a proposed prepayable capital structure.

Notably, both CVS and Aetna today announced that they would suspend share buybacks as of today to enable post-M&A debt reduction. CVS repurchased more than $4.8 billion of its shares over the 12 months to Sept. 30 this year, while Aetna bought back nearly $3.9 billion over the same span, according to S&P Global Market Intelligence.

S&P Global Ratings expects adjusted debt to EBITDA to lurch up to 4.5x–4.8x pro forma for the closing of the transaction—from 3.2x for the LTM period to June this year—and to remain above 4x for more than a year.

CVS’ own leverage targets are for 4.6x at closing, the mid-3x area two years post the closing, and the low-3x range ultimately, with rapid debt pay-down a priority in defense of the commercial-paper ratings. The companies also intend to maintain existing capitalization structures at the insurance subsidiaries in defense of their investment-grade profiles.

“The combination of CVS and Aetna will create a one of a kind vertically integrated healthcare company with huge scale and mark an industry shift towards a more seamless approach to managing healthcare costs as it brings together the overall management of a patient’s medical bills and prescription drugs under one umbrella”, said Moody’s Mickey Chadha in a research note. “However, the transaction will result in significant weakening of CVS’ credit metrics as it will be financed with a large amount of debt and will come with high execution and integration risks.”

Additional factors in the Moody’s downgrade review include the CVS’ exclusion from two new restricted network relationships between Walgreens and Prime Therapeutics, as well as between Walgreens and the Department of Defense Tricare program; reimbursement rate pressures, and weak front-end sales, which will exert drag on CVS earnings over the medium term, the agency noted.

Consideration for a deal would be in the context of Aetna’s $58.9 billion enterprise value at the start of the quarter, which included more than $9.1 billion of total debt and $3.6 billion of cash and equivalents, according to S&P Global Market Intelligence. CVS carried a total enterprise value of more than $101 billion into the current quarter, including $26.8 billion of total debt and $2.2 billion of cash and short-term investments. — John Atkins

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Amazon Lines Up Debt Backing $13.7B Whole Foods Buy, Shaking up Markets Along Way

Amazon (Nasdaq: AMZN) today disclosed $13.7 billion of bridge commitments for its proposed acquisition of Whole Foods Market (Nasdaq: WFM), outlining plans to issue senior unsecured notes, term loans, bridge loans, or a mix to finance the transaction, according to regulatory filings.

Whole Foods bonds gapped tighter on the news, but the development also sent a shudder through the credit markets for traditional grocery rivals and big-box grocery aspirants.

Earlier today, the Seattle-based internet retailing giant said it would pay $42 per share for Whole Foods in a cash transaction valued at roughly $13.7 billion. The deal is expected to close in the second half of this year. Whole Foods will be obligated to pay a fee of $400 million if the acquisition is terminated, regulatory filings show.

Amazon yesterday entered into a commitment letter with Goldman Sachs and BAML for a 364-day senior unsecured bridge term loan facility in an aggregate principal amount of up to $13.7 billion to fund the acquisition.

Neither Amazon nor Whole Foods are frequent issuers on the bond market. Amazon’s last bond placement was completed in December 2014, when it printed a $6 billion, five-part offering.

Whole Foods last tapped the market in November 2015, when it placed $1 billion of 5.2% 10-year notes due December 2025 at T+300, or 5.22%. Of note, the 2025 issue changed hands at T+198 ahead of this morning’s news, but gapped down to trades as tight as T+75 on the announcement, according to MarketAxess.

For reference, Amazon’s higher-rated 3.8% notes due Dec. 5, 2024 traded yesterday at T+43, or a G-spread of 62 bps, while its 4.95% bonds due Dec. 5, 2044 traded a modest five basis points wider this morning at T+106, or a G-spread of 115 bps, trade data show.

Proceeds from Whole Foods’ December 2025 deal were used to back a $1 billion share-repurchase program, which at the time triggered a change in outlook to negative, from stable, by S&P Global Ratings for its BBB– rating. The outlook was still negative as of the Amazon play, with S&P Global Ratings in February noting credit-protection strains amid competition in the natural and organic food space from traditional grocers and less conservative financial policies.

Moody’s maintained a stable outlook on its Baa3 rating for Whole Foods ahead of the M&A development.

The agencies at present maintain stable outlook on their respective—and disparate—AA–/Baa1 ratings profile for Amazon.

“We expect Amazon will continue to review potential acquisitions (usually funded by cash) and make substantial investments in new businesses around e-commerce, cloud computing, and entertainment consistent with its overall strategy of expanding the scale and scope of its operations (both horizontally and vertically) and will continue to benefit the company over the next few years,” S&P Global Ratings stated in ratings rationale published in February.

Of note, in February 2016, Moody’s revised its outlook on its Baa1 rating to stable, from negative, to reflect “its excellent liquidity and conservative financial policy relative to shareholder returns, and improving operating margins and strengthened quantitative profile despite prodigious growth-oriented spending and over $5 billion in ‘absorbed’ shipping costs.”

Notably, bonds backing traditional grocer Kroger continued sharply wider this morning, after its credit spreads lurched higher yesterday on its announcement of a material reduction in 2017 earnings guidance amid brutal margin pressures. The company acknowledged mounting competition from both new-store entrants, increasingly robust grocery offerings from Walmart, and the developing threat of digital competition from cash-awash online presences, and was pressed by analysts ahead of today’s news on the risks of competing with the much larger-scale and ambitious Amazon.

Kroger 4.45% bonds due Feb. 1, 2047 traded as wide as T+185 on the news this morning, or 20 bps wider on Amazon news and 30 bps wider since yesterday’s profit warning. (The notes dated to issuance in January at T+160.) Kroger five-year CDS continued 17 bps wider, or 20%, to a four-year high near 100 bps, from 71 bps before it slashed its guidance.

Meantime, the cost of five-year debt protection on the bonds backing Target and Wal-Mart Stores increased 12–14% today, and  TGT 3.625% 2046 bonds changed hands 10 bps wider, at T+125, trade data show.

Supervalu’s recently inked $840 million B term loan (L+350, 1% floor) was bracketing 99 this morning, down about a point from the last session, sources said. The loan freed to trade at the start of the month at 100/100.75. The issuer said it planned to use the proceeds in part to support its acquisition of Unified Grocers, in a bid to create one of the nation’s largest grocery wholesale companies. — Staff reports

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Intelsat debt, shares edge higher on 1Q results, new bond guarantee

Intelsat debt and shares advanced today after the satellite giant reported better-than-expected first-quarter results and reaffirmed its 2016 sales and earnings outlook based on the ongoing demand for broadband data, a heavy backlog of contracts, the successful launch of a new satellite last month, and preparation for the launch of more of its next generation fleet.

Most notably, however, investors heard that that a first-lien guarantee is now in place on a previously non-guaranteed series of Intelsat Jackson 6.625% senior notes due 2022, and that CC/Caa3 paper surged six points, to 64/65, according to sources.

Other bonds at various spots in the multi-tiered issuer were mixed. The previously guaranteed Intelsat Jackson 5.5% senior notes due 2023, which are notched higher, at CCC/Caa2, slipped two points, with trades reported on either side of 63, while the same entity’s first-lien 8% notes due 2024 dipped three quarters of a point, to 103.25/103.75, according to sources and trade data.

Meanwhile, at parent Intelsat Luxembourg 8.125% notes due 2023, which are a deeper step lower, at CC/Ca, the paper advanced two points, to 28.5/29.5, according to sources. And other “Jackson” bonds were steady, like the 7.5% notes due 2021, which held 69.5/70.5, the sources added.

Over on the NYSE, the company’s shares, which trade under the symbol “I,” increased roughly 6.5% this morning, to $3.93.

In the loan market, the Intelsat’s B-2 term loan due 2019 (L+275, 1% floor) was marked 94.125/94.625 on the results, up from either side of 94 prior, albeit a 95 context a week ago, according to sources.

Revenue in the quarter was $552.6 million, which was down from $602.3 million in the year-ago first quarter, but roughly 2% higher than the S&P Global Market Intelligence consensus estimate for $542.8 million, filings showed. As for the EBITDA result, first-quarter earnings were $407.5 million, which was down from $460.5 million last year, but right in line with the S&P GMI consensus mean estimate for $408.4 million.

Looking ahead, the company left unchanged via reaffirmation its full-year 2016 outlook for revenue of $2.14–2.20 billion and adjusted EBITDA to $1.625–1.675 billion, filings show.

Recall that the abovementioned, first-lien 8% notes were issued at par last month, with B–/B1 ratings, via Goldman Sachs and Guggenheim to support general corporate purposes, including prepayment in full of an intercompany loan of $360 million that upstreamed a dividend to parent “Luxembourg.” That issuance halted access to the “Jackson” undrawn revolver and triggered the guarantee to the 6.625% notes, according to a company statement.

Luxembourg-based Intelsat completed its IPO in April 2013, but a BC Partners–led group named Serafina still owns a majority of the satellite concern’s common shares. Prior to today’s rally, the company’s market capitalization on the NYSE was approximately $400 million. — Matt Fuller/Kerry Kantin

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