Notable Corporate Bonds Issued March 19, 2012

Includes: AIG, HUSKF, RIO
by: Rubicon Associates

After a lackluster Thursday and Friday of last week, the corporate bond market fired up its engines Monday with issuance of $7.5 billion (fewer big deals - I'd rather see more smaller deals). Given the rise in the treasury rates last week, corporates performed well, grinding in 7bps on the CDX IG, adding over $1.30 on the HY and shaving 54bps off the crossover index. This is to be expected when rates rise like they did and should continue to help relative performance going forward.

The following were the issues that came to market on March 19:

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What was notable Monday? I found the American International Group (NYSE:AIG) deal interesting (prospectus). The use of proceeds for the issues is: Subsequent to this offering, AIG expects to use approximately $1.5 billion of existing funds allocated to the Matched Investment Program (the "MIP") to pay down all the AIA SPV Preferred Interests, and in exchange, to allocate to the MIP a greater amount of assets, which may include (subject to certain regulatory and third party approvals) AIG's remaining interests in ML III and the $1.6 billion in cash held in escrow to secure indemnities provided to MetLife, each of which will be released as security supporting the AIA SPV Preferred Interests upon the pay down in full. AIG expects to use the proceeds of this offering to enhance the derisking of, and better match the assets and liabilities in, the MIP.

Lets review some of their acronyms:

Matched Investment Program [MIP]: The Direct Investment book includes results of the MIP, AIG's historical program to generate spread income from investments yielding returns greater than AIG's cost of funds, and certain non−derivative assets and liabilities of AIGFP. The MIP assets and liabilities and the AIGFP portfolio are currently managed on a collective program basis to limit the need for additional liquidity from AIG Parent. Direct Investment book operating results are significantly affected by performance in the credit, equity, interest rate and foreign exchange markets. Basically, the company borrows money at their market rates and invests the proceeds into investments at a higher rate, thereby earning the spread. Don't let the name fool you though, they crushed this book by mismatching their investments (well, they were matched on a match to model basis - ummm, KABOOM in 2008).

Maiden Lane III [ML III]: In November 2008, FRBNY created this SPV to provide AIG liquidity by purchasing collateralized debt obligations (CDOs) from AIG Financial Products Corp. counterparties in connection with the termination of credit default swaps (CDSs) and surrender of the collateral by AIGFP. FRBNY provided a loan to the SPV for the purchases. The original amount funded by the FRBNY was $24.3 billion. Loans to ML III are being repaid with the proceeds from the interest and principal payments and/or from the liquidation of the assets in the facility.

From the 10k:

At their inception, AIG's interests in ML II and ML III were valued and recorded at the transaction prices of $1 billion and $5 billion, respectively.

Subsequently, AIG's interest in ML III has been valued using a discounted cash flow methodology that (i) uses the estimated future cash flows and the fair value of the ML III assets, (ii) allocates the estimated future cash flows according to the ML III waterfall, and (NASDAQ:III) determines the discount rate to be applied to AIG's interest in ML III by reference to the discount rate implied by the estimated value of ML III assets and the estimated future cash flows of AIG's interest in the capital structure. Estimated cash flows and discount rates used in the valuations are validated, to the extent possible, using market observable information for securities with similar asset pools, structure and terms.

AIG does not believe a change in the fair value methodology used for its interest in ML III is appropriate at this time based on current available information. Other methodologies employed or assumptions made in determining fair value for these investments could result in amounts that differ significantly from the amounts reported.

Lets look at the assumptions:

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And how does one match this nonsense? Why "match to model" of course. Matched investment program is laughable as a title and a program.

This is the second time in six months that AIG has issued debt to refinance the MIP debt: On September 13, 2011, AIG received approximately $2.0 billion in proceeds from the issuance of senior unsecured notes. AIG used the proceeds from the sale of the notes to pay maturing notes that were issued by AIG to fund the Matched Investment Program (MIP).

With that said, I have been surprised at AIG's progress to repay the Treasury loans and the rescue package. While interesting and potentially compelling at +265/5yr, I am not yet a buyer of AIG.

Rio Tinto (NYSE:RIO) hit the market for $2.5 billion with the use of proceeds stated as general corporate purposes (prospectus). Rio has less than 1x EBITDA in debt (inclusive of the new issuance) and has done a remarkable job integrating acquisitions (of which I am sure there will be more). Earnings covered fixed charges by 13.2x

The notes are unsecured, unsubordinated indebtedness of Rio Tinto Finance (USA) plc and and will be guaranteed by Rio Tinto plc and Rio Tinto Limited.. The guarantees of the notes will be unsecured, unsubordinated obligations of Rio Tinto plc and Rio Tinto Limited. The guarantees will rank equally with all other unsecured and unsubordinated indebtedness of Rio Tinto plc and Rio Tinto Limited from time to time outstanding.

The covenant package is slim (as would be expected):

  • The company can merge with, or sell substantially all their assets to, another company as long as the company becomes the successor obligor and is organized under the laws of Australia, the UK or the US, depending on the guarantor.
  • There is a limitation on liens with a 10% carve out ( liens are permitted as long as they are below 10% of Rio Tinto's consolidated net worth plus minorities. Consolidated net worth plus minorities is defined in the indenture as a measure of the net worth of Rio Tinto that includes amounts attributable to the outside interests).

RIO 3.75% of 2021 trade around +110/100, so there is some value in the 10yr debt at +120/10yr.

Husky (OTCPK:HUSKF) (prospectus) has less than 1x cash flow in debt, below 20% on a debt to capital basis and earnings cover LT debt interest by 7.7x (cash flow covers LT debt interest by 14.6x). Very strong credit, has been for a long time. I like the name.

Covenants (standard IG covenants):

  • Limitation on liens - standard limitations with a carve out of 10% of Consolidated Net Tangible Assets.
  • Consolidation, Merger or Sale of Assets - Allowed as long as the successor obligor is organized under the laws of Canada, any state in the US or the District of Columbia.

HSECN 7.25% due 2019 trades 118/08, 7.55% due 2016 trade +135/125. At +160/10 and a current coupon (although it will have a longer duration due to the coupon and maturity), the new issue presents value for an investor.

All in all, a decent day in the new issue market and some value to be had in the new issues.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.