Need further evidence of the condition of the corporate bond market?
Caterpillar Corporation (CAT) is a frequent visitor to the public debt markets through its subsidiary, Caterpillar Financial Services. In August of this year, Caterpillar sold 5-year notes with a spread to treasuries of 175 basis points.
By mid-September, the notes traded at a 225-point spread, and Caterpillar brought a new issue of 10-year notes at a rate equal to a 325 basis point spread.
Last week, the company sold a new 3 tranche issue totaling $1.5 billion with a 535-point spread on 5-year notes, a 525-point spread on the 10-year notes and a 510-point spread on $250 million of 30-year bonds.
Hewlett Packard (HPQ), another blue chip company (A rated by Standard & Poor’s) also entered the market his past week, offering $2 billion of 5-year notes at a spread of 460 basis points. HPQ bonds of a similar maturity most recently traded at plus 358 basis points in the secondary market.
At the same time that Hewlett Packard and Caterpillar were issuing their debt, several other new issues came to market under the Treasury Department’s new program of providing a federal guarantee for bonds of highly rated companies.
Citigroup (C), John Deere (DE), Bank of New York Mellon (BK) and Comerica (CMA) opted to participate in the Treasury Department program. With the benefit of the guarantee, Citi was able to sell notes at a spread of 188 basis points.
While the federally guaranteed bonds offer a distinct advantage, credit quality advantage over non-guaranteed corporate notes, institutional investors still required a premium over the direct guarantee carried by treasury securities.
At the same time, those companies that don’t have access to the guarantee program are trading at historically high spreads, as the market is building in a default rate of over 20% on high-yield corporate debt. That premium is also affecting the offerings of quality companies like Caterpillar.
For the investor in corporate bonds, the current market dynamic offers tremendous upside opportunities. Bonds purchased at the premium spreads being required provide high current returns, as well as high returns at maturity. They also present an opportunity for capital gains as the economy strengthens and the value of holdings in this sector increase.
Investors adding corporate bonds to their portfolios need to fully understand the risks they are taking. Careful analysis of the company’s financial statements is essential to a successful investment strategy in bonds.
Both Caterpillar and Hewlett Packard retain high credit ratings and should be a part of a corporate bond portfolio.