In recent months, we have seen a number of investment-grade industrial issuers tender short- and intermediate-term bonds and issue long paper given the continued flattening in the corporate yield curve. This corporate behavior may be motivated by a number of objectives, such as decreasing interest costs in the low-rate environment or more strategically, reducing refinancing needs at a relatively low cost.
Market conditions are ripe for more issuers to utilize these duration extension trades. As reflected in today’s chart, yield curves remain flat, allowing issuers to term out debt at a very low incremental cost. The yield differential between 5-year and 30-year corporate industrial bonds is the lowest since early 2009.
Today’s chart demonstrates how in past instances, where the cost for issuers to extend was minimal, corporate issuers reduced the portion of their debt in the intermediate part of the curve. The tender-and-extend exercise has not only brought about strong performance in front-end bonds of issuers that pursue this strategy, but front-end credit more broadly. The unavailability of front-end paper has been a strong technical driver – for example, AT&T and AB InBev have seen strong front-end performance from the tender-and-extend practice. In addition, there are more names in the consumer non-cyclical sector that may pursue this strategy. Some issuers that have engaged in largely debt-funded M&A in recent years still maintain somewhat elevated leverage. Given concerns surrounding future growth prospects, these companies could quite possibly seek to manage their refinancing needs before a possible cycle turn, and extend maturity walls.
Naturally, this issuer behavior has led to supply that is heavier in the long end. The average tenor of issuance is 14.5 years, up from 12.3 years in full-year 2018 and 11.6 years in 2017. New issuance year-to-date in bonds 20 years and longer represents 34% of total issuance versus mid-20% in recent years.
The front-end bid for credit will likely remain robust as supply in this part of the curve has diminished. The flat corporate industrial yield curve has incentivized issuers to tender and extend, or simply issue long paper, given the minimal incremental cost. I expect this trend to continue until we see a steepening in the curve.
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This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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