First Quarter Ripe With New Bond Issuance

The new issue market capped off a nearly record-breaking first quarter on a strong note. Issuers took advantage of historically low interest rates, tight corporate credit spreads, and strong investor demand to price bonds with coupons near all-time lows. Among the issuers we rate, $11 billion of volume priced, ranging from Heineken, which priced its inaugural U.S. dollar-denominated bond, to repeat issuers in the basic materials sector. We expect new issue volume this week will be muted, as many traders will begin to disappear by midweek to take time off for the Easter holiday.

Credit spreads were largely unchanged during the week as the Morningstar Corporate Bond Index held steady at 181 basis points over Treasuries. Over the course of the quarter, the Morningstar Corporate Bond Index tightened about 70 basis points. We first highlighted that credit spreads were fundamentally cheap last October, and we continue to think that credit spreads will contract over the next few months, potentially tightening back to last April's levels (+134). Traders reported good secondary trading volume over the course of the week and noted that there appeared to be better sellers of short-dated and long-dated paper, with higher demand for 5- to 10-year bonds.

The 10-year Treasury traded within a 10-basis-point range and ended the week 1 basis point tighter at 2.22%. However, we are doubtful that interest rates will remain this low for very long. With no additional quantitative easing programs on the horizon, Operation Twist winding down by early summer, and the safe-haven demand for Treasuries dwindling, we continue to think that interest rates are poised to rise over the next few months.

Among sovereign bonds, the spread on Italian 10-year bonds over German bonds widened 14 basis points to +332 and the spread on Spanish 10-year bonds widened 5 basis points to +356. Neither move is of concern yet, but we will keep a close eye on both. If the credit spread on either bond breaches +400 basis points, renewed headline risk out of Europe would cause us to re-evaluate our outlook for continued corporate credit tightening.

New Issue Commentary
Barrick Gold's New Bonds Unlikely to Come Cheap (March 29)
 Barrick Gold (ticker: ABX, rating: BBB+) is coming to market with benchmark-sized 10- and 30-year notes. Proceeds will probably be used to repay the rest of the bridge facility Barrick took out for the CAD 7.3 billion Equinox acquisition and to fund the company's aggressive capital expenditure plan. Barrick's existing 2021 notes trade at an interpolated spread of 150 basis points and its 2041s at a spread of 175 basis points. Both bonds are trading slightly tighter than  Newmont's (ticker: NEM, rating: BBB+) new issue of three weeks ago. Newmont's 2022s came in at a spread of 160 basis points and are now trading at a spread of 168 basis points. Similarly, its 2042s came in at a spread of 180 basis points and have since widened to 190 basis points. Both names are trading inside the BBB+ names in the Morningstar Corporate Index (excluding financials), which sports a spread of 174 basis points above Treasuries (with an average maturity of 10 years). Provided the new bonds come in at spreads commensurate with Barrick's outstanding issues, we wouldn't see much relative value in either name. We'd peg fair value in the neighborhood of 160-180 basis points for the 10-year notes and 180-200 basis points for the 30-year notes.

Despite a supportive gold price environment compared with historical standards, we think most gold mining companies have very limited capacity for generating free cash flow, particularly after factoring in a higher dividend outflow in the near term. In the case of Barrick, we estimate free cash flow will be barely break-even in 2012 after $5.7 billion in capital expenditures (mostly pertaining to two massive projects) and another $600 million in dividends. While we expect more modest capital outlays thereafter, levels will remain high relative to operating cash flows, diminishing free cash flow generation.

In mining, we prefer  Southern Copper (ticker: SCCO, rating: BBB+). For instance, Southern Copper's 2035s offer a spread of 307 basis points versus the curve, well wide of Barrick's similar-dated bonds. We think Southern Copper offers more attractive relative value and gives long-term investors appealing exposure to a low-cost copper producer.

USG to Offer New Senior Notes to Fund Tender of Its 9.75% Senior Notes; We Would Buy the Bonds (March 29)
 USG (ticker: USG, rating: CCC) is in the market with a new $250 million senior note to fund the ongoing tender offer for its $300 million 9.75% senior notes due 2014. The new notes will be an 8-year noncall 4 structure and will rank pari passu to the notes being tendered for, as well as the firm's 8.375% senior notes due 2018. These notes are structurally superior in the capital structure relative to two other senior notes (totaling $1 billion of the firm's $2.3 billion in total debt) as a result of guarantees provided by certain domestic subsidiaries. As such, each of the three rating agencies gives these notes two-notch upgrades from the corporate rating, with expectations of very high recoveries in a default scenario. USG has received about $118 million of tendered bonds thus far, but has extended the early tender date to April 2. The firm is offering $1,125 per each $1,000 bond. USG's 8.375% bonds were recently indicated at a yield to worst of about 7.1%, resulting in an option-adjusted spread of about 590 basis points above Treasuries. The 9.75% notes were trading around 6% (and a spread of about 560 basis points) before the tender announcement. As such, we would expect the new bonds to price in the area of 7.5%-7.75% given the longer maturity. We view these levels as attractive, considering the position in the capital structure and our view that this is an improving credit.

We increased our equity fair value estimate in early February on the basis of improving fundamental trends in the construction markets. Last week the firm provided an update on operating results for January and February, which included a sharp increase in sales along with operating profits as opposed to operating losses last year. This prompted us to once again place our equity valuation under review as we assess the new pricing dynamic of its wallboard products. This, along with an improved maturity schedule likely to result from the tender of the 9.75% notes and new issue, could also result in an increase in our credit rating.

Heineken's Inaugural U.S. Dollar-Denominated Bond Issue Is Fully Valued (March 29)
In its first U.S. dollar-denominated issue,  Heineken (ticker: HEIA, rating: A-) is bringing $500 million in 10-year notes to market Thursday morning. Two weeks ago, the firm priced its first euro-denominated public bond issues in Europe. Those issues consisted of EUR 850 million in 7-year and EUR 500 million in 12-year notes, which were priced at 145 and 180 basis points above German bonds. Both issues are reportedly trading about 20 basis points tighter in the secondary market.

The whisper talk on the new U.S.-dollar 10-year notes is 135-140 basis points above Treasuries, which we think is fully valued compared with the firm's existing euro-denominated bonds and other global brewers. Heineken's new notes are reportedly being issued under Rule 144A, which limits the universe of potential buyers.  SABMiller's (ticker: SAB, rating: A) 3.75% senior notes due 2022 are indicated at a spread of 130 basis points above Treasuries and  Anheuser-Busch InBev's (ticker: BUD, rating: BBB+) 4.375% senior notes due 2021 are indicated at 85 basis points above Treasuries. While the new Heineken issue will be well received by the market and probably tighten slightly in the secondary market, we think SABMiller notes have significantly more upside and will tighten toward AB InBev's levels over time. Because of its upside potential, SABMiller is on our Best Ideas list. We rate SABMiller one notch higher than Heineken and two notches higher than AB InBev.

Investors Should Consider Svenska Handelsbanken's New 5-Year Notes (March 28)
Svenska Handelsbanken (ticker: SHB A, rating: A+) announced today that it is issuing new five-year benchmark dollar-denominated notes. Whisper on price guidance is in the area of 195 basis points over the Treasury curve. From a credit perspective, we are very comfortable with Svenska Handelsbanken. It is one of Sweden's largest banks, with operations in four other countries. It has more than 460 branches and assets of more than SEK 2.1 trillion. The bank's main market is Sweden, in which it's part of a four-party oligopoly. Handelsbanken has a history of maintaining a conservative credit underwriting profile and, unlike peers, tends not to chase growth. The result is a very low-risk loan book with minimal credit costs (the loan losses/loans ratio typically stays below 0.20%). Even in the early 1990s when all Swedish banks were overwhelmed by a severe crisis, Handelsbanken was the only major institution that sidestepped the wreckage. The bank is very well capitalized as its Tier 1 ratio is over 18% and its Core Tier 1 is over 15%.

At the price talk, we think this deal is attractive. Yesterday,  HSBC (ticker: HBC, rating: A+) came with a 10-year deal that priced at +190 and currently trades about 5 basis points tighter. We rate both banks the same and view these banks as two of the strongest banks in Europe. In the United States, we rate  Wells Fargo (ticker: WFC, rating: A+) the same as the other two, and its five-year trades in the +120 area. We think investors are well compensated in receiving 75 basis points in spread pickup for having exposure to European headline risk, which should be muted for a while thanks to the European Central Bank's long-term refinancing operations program. We would recommend this deal all the way down to a spread of +160.

Click here to see more new bond issuance for the week ended March 30, 2012.