- On July 7, there were 17,088 trades in 3,130 non-call fixed rate senior debt issues worth $4.1 billion.
- We rank the "best value" trades by the ratio of credit spread to matched maturity default probability.
- Issues by Bank of Nova Scotia, Goldman Sachs, PNC, UnitedHeath Group, and Bank of Montreal lead the rankings.
Today we rank the best value fixed rate senior corporate bond trades with daily trading volume of at least $5 million and maturities of 1 to 5 years or longer on July 7, 2014. On July 7 in the U.S. bond market, there were 17,088 bond trades in 3,130 non-call fixed rate senior corporate bond issues representing $4,077,389,824 in notional principal. Which 20 trades were the best trades of the day, and how do we decide the answer to that question? Today, we answer those questions for bonds with maturities of 1 to 5 years.
Conclusion: We find the best-value non-call senior fixed rate 1 to 5 year maturity bond trades on July 7, 2014 were issues by these firms:
BANK OF NOVA SCOTIA (NYSE:BNS), 3 issues
GOLDMAN SACHS GROUP INC. (NYSE:GS), 3 issues direct and one affiliate
PNC FUNDING CORPORATION (NYSE:PNC)
UNITEDHEALTH GROUP INC. (NYSE:UNH)
BANK OF MONTREAL (NYSE:BMO)
ST. JUDE MEDICAL INC. (NYSE:STJ)
NATIONAL AUSTRALIA BANK LTD. NEW YORK BRANCH (OTCPK:NABZY)
BUNGE LIMITED FINANCE CORPORATION (NYSE:BG)
VESEY STREET INVESTMENT TRUST I
CANADIAN NATIONAL RAILWAY CO. (NYSE:CNI)
AMERICAN EXPRESS CREDIT CORPORATION (NYSE:AXP)
DOMINION RESOURCES INC. (NYSE:D)
AMERICAN EXPRESS BANK FSB
ECOLAB INC. (NYSE:ECL)
DIRECTV HOLDINGS LLC (NASDAQ:DTV)
COMERICA INC. (NYSE:CMA)
Best Value 1 to 5 Year Bond Trades for July 7, 2014
In analyzing the best trades of the day, we used these criteria:
Bond type: Fixed rate
Callability: Non-call, except for "make-whole" calls
Seniority: Senior debt
Trade Volume: $5 million or more
Maturity: 1 to 5 years
We ignored legacy ratings in making today's selection, but all but 2 of the 94 trades meeting our criteria had an investment grade rating by the pre-Dodd Frank Act definition. We used the same criterion for "best" that we have used in recent analyses of bonds issued by Kraft Foods Group Inc. (NASDAQ:KRFT), Amgen Inc. (NASDAQ:AMGN), and Caterpillar Inc. (NYSE:CAT). That criterion is the reward to risk ratio, calculated as the ratio of credit spread to matched-maturity default probability. The default probabilities used are described in detail in the daily default probability analysis posted by Kamakura Corporation. Both the credit spreads and default probabilities are reported as percent figures. The full text of the 2010 Dodd-Frank legislation as it concerns the definition of "investment grade" is summarized at the end of our analysis of Citigroup (NYSE:C) bonds published December 9, 2013.
In all, there were 94 issues that met our criteria. The distribution of credit spreads is given in this histogram:
The median credit spread was 0.424% and the average credit spread was 0.532%. The distribution of the credit spread to default probability ratio is given in this histogram:
The median credit spread to default probability ratio was 16.387 and the average was 27.143.
Here are the ranking results, listed from best to worst, with a Bank of Nova Scotia bond issue the winner at a reward to risk ratio of 152 times:
Many investors have requested that we provide CUSIPs as part of this chart. Redistribution of CUSIPs is currently prohibited by Kamakura Corporation's contract with the data vendor. We are working hard to change this so that we may make CUSIPs available in the future. In the meantime, CUSIPs for major issuers can be found easily with an internet search on web pages like this one from the New York Stock Exchange.
Background on the Calculations
Assuming the recovery rate in the event of default would be the same on all bond issues, a sophisticated investor who has moved beyond legacy ratings seeks to maximize revenue per basis point of default risk from each incremental investment, subject to risk limits on macro-factor exposure on a fully default-adjusted basis.
Maximizing the ratio of credit spread to matched-maturity default probabilities requires that default probabilities be available at a wide range of maturities. We used the default probabilities supplied by Kamakura Corporation's KRIS default probability service, interpolated to a matched-maturity basis to the exact day of bond maturity. For maturities longer than ten years, we assume that the ten-year default probability is a good estimate of default risk.
Bond yields are secured from TRACE. The National Association of Securities Dealers launched the TRACE (Trade Reporting and Compliance Engine) system in July 2002 in order to increase price transparency in the U.S. corporate debt market. The system captures information on secondary market transactions in publicly traded securities (investment grade, high yield and convertible corporate debt) representing all over-the-counter market activity in these bonds.
We used the trade-weighted average yield reported by TRACE for each of the bond issues analyzed. We calculated the credit spread using the matched-maturity yield on U.S. Treasury bonds, interpolated from the Federal Reserve H15 statistical release for the trade date. The source of the information on the H15 release is the U.S. Department of the Treasury.
Forward-Looking Best Value Bond Selection
Today's analysis looks back at yesterday's trades. A forward-looking bond selection based on today's prices at this instant is done in the same way, with slight differences in the data sources.
Regular readers of these notes are aware that we generally do not list the major news headlines relevant to the firms in question. We believe that other authors on Seeking Alpha, Yahoo, at The New York Times, The Financial Times, and The Wall Street Journal do a fine job of this. Our omission of those headlines is intentional. Similarly, to argue that a specific news event is more important than all other news events in the outlook for the firm is something we again believe is inappropriate for this author. Our focus is on current bond prices, credit spreads, and default probabilities, key statistics that we feel are critical for both fixed income and equity investors.