In the last week, we saw the largest emerging market bond deal in history, a $17.5B-denominated sovereign debt debut from Saudi Arabia. We also saw a first-of-its-kind $3.5B spectrum-backed asset-backed security offered by Sprint (NYSE:S). We also saw some important comments from Mario Draghi, the President of the European Central Bank, on the state of quantitative easing in Europe.
A discussion of these unique bond deals can help frame relative value in global bond markets and for credit markets in the U.S. As we have learned through this period of extraordinary monetary accommodation, the impact of central bank actions can extend from fixed income to all major asset classes. This article will highlight some of the key factors of these market-shaping events, and discuss the implications for financial markets moving forward.
1. The Saudis are Coming
Saudi Arabia (A1/AA-) established a curve for their dollar-denominated debt in a record issuance that priced on Wednesday. Saudi Arabia is the 20th largest economy in the world in nominal terms, producing roughly the economic output of Switzerland. It has never had to issue dollar-denominated external debt before given its large dollar revenues earned from being the world's largest oil producer. The country's fiscal deficits at greater than 10% of GDP, roughly the size of the U.S. deficits during the Great Recession, signal that Saudi Arabia will need to continue to tap international bond markets until oil prices recover, or the country right-sizes spending to its lower revenues. A transition towards a more diversified economy will be a long process. This record debt deal will be followed by more to come.
2. Where Should it Trade?
Where should a sovereign with a great balance sheet (low debt/GDP, enormous reserves) and a poor income statement (high budget deficits, large current account deficit) trade in the global bond market? The 5-yr tranche printed at a spread of 135bp to yield 2.59% at issuance, the 10-yr tranche was priced at a spread of 165bp to yield 3.41%, and the 30-yr bond offered a spread of 210bp to yield 4.61%. The bonds have traded up 1pt in the front end and 2pts in the long end post-issuance.
On the same day the Saudi deal was issued, Nike (NYSE:NKE) came to market with new 10 and 30-yr debt. Now these two entities have very different risks, but carry the exact same credit ratings from the two major agencies (A1/AA-). Nike printed its 10-yr at a spread of just 65bp, and a yield of 2.39%, which was inside the yield on the 5-yr issuance of Saudi Arabia. The 30-yr Nike deal was at a spread of 93bp to yield 3.43%, or 117bp through where Saudi Arabia printed its long debt.
If you are a long-term bond investor, it is still easier to picture what Nike might look like in thirty years than portend the credit profile of Saudi Arabia given the potential for secular declines in the oil industry and the potential for geopolitical risk that could potentially challenge the monarchy. Investors need to get paid for this perceived political risk.
A more natural comparison for Saudi Arabia might be Statoil (NYSE:STO), the integrated oil giant that is two-thirds controlled by Norway. While Norway has much lower levels of oil reserves than Saudi Arabia, it boosts a more diversified, albeit smaller, economy. Both countries are technically monarchies, but while the royal family dominates the political system in Saudi Arabia, Norway operates a parliamentary form of government where the king is the head of state, but the prime minister is the head of government. Statoil, which is rated Aa3/A+, one notch higher at Moody's and one notch lower at S&P than Saudi Arabia, printed its last dollar-denominated 10-yr in November 2014 just before the oil drawdown at a spread of 98bp/10yr Treasury. The seasoned 10-yr now trades at a spread of around 65bp, which is 100bp through the Saudi on-the-run 10-yr.
Qatar (Aa2/AA/AA) issued a 10-yr in May 2016 at a spread of 150bp with bonds now trading around 125bp. For reference, Israel (A1/A+/A) issued a 10-yr dollar-denominated deal in early March 2016 at a spread of 105bp, with that deal now trades around 65bp, or around 100bp tighter than the Saudi deal.
The Saudi Arabian deal came a little cheap to comparables given that this was an introductory deal for the issuer. I would be strongly biased towards the shorter tranches that offer spreads equivalent to BBB rated domestic credit. While a coupon approaching 5% might be attractive to some investors, I cannot recommend the longer duration bonds until Saudi Arabia makes some tangible progress in diversifying its economy and right-sizing state spending to its government revenues.
3. What was this Sprint deal?
Sprint issued $3.5B of secured debt that is backed by the company's 1.9 GHz and 2.5GHz that a third party valued at over $16B. Sprint is selling this spectrum into a bankruptcy remote entity with the transaction backed by a lease from Sprint Corporation (rated B3). Rating agencies assigned mid-BBB ratings to this senior secured Sprint deal, allowing far lower borrowing costs than is typical for Sprint unsecured debt.
At this ratings level, Sprint can print up to $7B of debt. During a long road show for the debt with the bankers and Sprint/Softbank management meeting with potential investors, the initial price talk was for a 5-yr maturity/3-yr average life in the high 4% area, a 7-yr maturity/5-yr average life in the low to mid 5% area, and a 10-yr maturity/7.5-yr average life in the mid-high 5% area.
Sprint ended up only bringing the 5-yr maturity to market, and given the tremendous demand for the deal, the debt tightened all the way to 3.375%. Bonds have continued to perform tightening all the way inside 3%. Printing only the shortest tranche, and seeing the debt perform so strongly likely opens Sprint up to print the intermediate tranches at tighter levels.
4. What are the implications for Sprint and the telecom space?
Sprint has turned an asset that does not produce cash flow into one of its most valuable sources of low cost funding. The ability to borrow directly against the company's most valuable assets will aid the company's liquidity position as it continues its long-run operation turnaround.
Given the success of this deal, we are going to see more telecom companies access this type of transaction. While Verizon (NYSE:VZ) and AT&T (NYSE:T) are both strong investment grade companies that can readily tap debt markets, both can still gain from this low cost secured financing. Verizon must continue to be proactive in refinancing the debt from its takeover of Vodafone's (NASDAQ:VOD) stake in Verizon Wireless in 2013 that led to the largest bond deal in history. AT&T will ultimately look to term out the $40B bridge loan it has obtained from its recently announced takeover of Time Warner (NYSE:TWX).
5. How should I interpret Draghi's statements, and what are the implications for asset prices?
Given the impact central bank policymakers have had on financial markets over the last several years, comments from Draghi can have an outsized impact on asset prices. In July 2012, Draghi promised to "do whatever it takes" to preserve the euro, arresting declines in European assets and setting global assets up to rebound. Ultimately, this commitment to European financial market stability and the single currency led to the beginning of quantitative easing in 2015. With the United States in the halting stages of normalizing monetary policy, investors are right to question whether the ECB will follow in tapering asset purchases. Draghi said that quantitative easing is unlikely to come to an abrupt end, and we should expect that any reduction in extraordinary monetary accommodation will be well telegraphed as it has been in the United States. Markets have reason to believe Draghi's commitment, and the euro fell to an eight-month low. Monetary policy in the Eurozone will stay easy as the continent continues its frustratingly slow economic recovery. Investors in U.S. markets will need to remain wary of the impact of policy divergence between the U.S. and E.U., and the impacts of a dollar that could be pressured higher.
It was a fascinating week. Two historic debt debuts in the sovereign and asset-backed security market, and some important commentary from a leading economist. I hope this article summarized this new market information for Seeking Alpha readers.
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