Enticed By Low Yields, Companies Sell Debt In Risky Climate

Four companies are wading into the U.S. debt markets Tuesday to take advantage of the drop in corporate bond yields over the last week, but investors are demanding higher yields to compensate them in this risky climate.

Zurich Insurance Group Ltd. and U.S. retail chain Kroger Co. (KR) are leading the new-issue market with benchmark-size deals, along with smaller deals from Mack-Cali Realty Corp. (CLI) and the Idaho Power Co.

The four issues follow the lightest week for volume in 2012, according to Dealogic, and this week is shaping up to be even softer. No borrowers tried issuing Monday in the wake of the soft U.S. payrolls report Friday, but the environment was looking stable Tuesday morning with a flat stock market and only minor weakening in Markit's CDX North American Investment-Grade Index, a proxy for risk sentiment.

Stocks have since tumbled and the CDX index had worsened 2.4%, but companies are attracted by the low Treasury rates that corporate bonds are based upon. The 10-year Treasury rate has now dropped at 1.98%, or 0.25 percentage point down from the 2.23% rate just before the payrolls report.

That's a big motivator. Though corporate bonds haven't kept pace with the Treasury rally, causing spreads to widen, absolute yields have dropped in the Barclays investment-grade index. Average yields finished Monday at 3.37%, compared with 3.47% on April 3, even as spreads widened 0.08 point in the week.

"All-in yields are the reason these companies are getting in," said Vincent Murray at Mizuho Securities. "That's got to be attractive for anyone who needs to issue debt, but it's a toss-up because fast-money accounts start to step back when things get shaky."

A counterweight to falling yields is that investors could start demanding higher "concessions"--the extra yield on new bonds--to mitigate potential losses in a riskier environment.

Kroger might be an example of that. Early pricing guidance suggests it is selling 10-year and 30-year bonds at 1.50 and 1.85 percentage points over Treasury rates. Its outstanding 30-year bond due 2040 traded Monday at 1.58 points over Treasurys, suggesting investors are picking up 0.22 point by purchasing the new bond.

But Mack-Cali Realty recently launched its 10-year offering at 2.55 points over Treasurys, a slightly better level than the 2.60-point spread reported earlier, and the deal was enlarged by $50 million to $300 million.

"Investors are realizing they could get burned on these low rates, so they want to be compensated for the risk, but at the same time there isn't enough attractive debt out there to put money to work, leading to these competing forces," said Jody Lurie, corporate credit analyst at Janney Capital Markets.

Even before the payrolls report, actively traded new deals were weakening in the secondary market, according to Scott Kimball, portfolio manager at Miami-based BMO TCH Corporate Income Fund, which holds $7.3 billion in assets under management.

"The performance following new issuance is the weakest it has been in a long time," he said. "The new-issue market is feeling saturated. If spreads go wider, equity markets remain weak, and Treasurys rally, we'll have to see bigger concessions to get deals done."

Since the French media company Vivendi SA (VIVEF, VIV.FR) sold $800 million of 10-year bonds on April 3 at 2.50 percentage points over the Treasury rate, spreads have jumped 0.15 point to 2.65 points, according to MarketAxess.

-By Patrick McGee, Dow Jones Newswires; 212-416-2382; patrick.mcgee@dowjones.com

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