Outlook 2020: High-grade bond spreads mostly expected to improve; bank paper to grind tighter

By Cristal Cody

Tupelo, Miss., Dec. 31 – The investment-grade bond market saw annualized returns of 15% and more in 2019, while 2020 has the potential to post 6% total returns.

“This year is drawing to a close with 92% of all assets across the globe having produced positive total returns, a breadth of asset price appreciation on par with ‘09 – a time when the global economy was emerging from the Lehman episode,” BofA Securities Inc. global analysts said.

Spreads were helped with the Federal Reserve’s three rate cuts in 2019. Most market analysts do not expect any rate changes in 2020.

“Heading into 2020 the balance of things is less obvious than in 2019,” the BofA analysts said. “But for now – and the foreseeable future – the environment is quite favorable for credit spreads with major global central bank balance sheets now again expanding after having contracted in 2018 and through September this year, and 48 net rate cuts this year following 42 net hikes in 2018.”

Investment-grade spreads are expected to maintain the trading range seen over the last five months of 2019, Morgan Stanley & Co. LLC analysts said in a research report.

In 2019 with a low-yield backdrop, the investment-grade market “has traded more like a sovereign bond proxy rather than a credit product in recent months, ignoring the weak earnings backdrop at a macro and micro level,” the analysts said.

Bond spreads tighten

High-grade credit spreads were about 30 basis points tighter on the year by December.

The Markit CDX North American Investment Grade 33 index closed on Dec. 13 at a spread of 47.9 bps, compared to where the index finished Dec. 13, 2018 at a spread of 77 bps.

In 2020, high-grade bond spreads are expected to tighten to 90 bps by the first half of the year, according to BofA analysts.

Spreads are expected to firm before moving wider in 2020, according to a Wells Fargo Securities LLC research report.

Bond spreads are likely to finish the new year 15 bps to 20 bps wider and with a point estimate of 120 bps, the note said.

“This would result in full-year excess return of 50 bps and total return of 1.5%,” the Wells Fargo analysts said. “Strong technicals early in the year are likely to eventually give way to less favorable credit fundamentals and weaker technicals later in the year.”

Bank spreads are expected to grind tighter on a forecasted 10% to 20% supply increase in 2020, according to Wells Fargo.

In 2019, banks had a strong year tightening 60 bps on a spread basis, but the “biggest driver remains supply underwhelming already low expectations, particularly in dollars,” the Wells Fargo analysts said.

Bank spreads are expected to grind tighter on a forecasted 10% to 20% supply increase in 2020, according to a Wells Fargo research report.

In 2019, banks had a strong year tightening 60 bps on a spread basis, but the “biggest driver remains supply underwhelming already low expectations, particularly in dollars,” Wells Fargo said.

Bank of America Corp.’s $3 billion of 3.974% medium-term fixed-to-floating rate senior notes due Feb. 7, 2030 (A3/A-/A+), which priced early in the year on Feb. 4, traded in late December in the 90 bps bid area, a market source said.

The bank priced the notes at par to yield a spread of Treasuries plus 125 bps, compared to initial talk in the Treasuries plus 140 bps area.

The notes will reset to a rate of Libor plus 121 bps beginning Feb. 7, 2029.

One of the secondary market’s bright spots in 2019 was from aircraft lessors, with the subsector 110 bps tighter on average, Wells Fargo said.

REIT spreads also have tightened about 53 bps through early December following strong supply in 2019.

Energy bond spreads are likely to remain volatile in 2020, according to the Wells Fargo report.

The energy space “went from the top one or two performing IG sectors through May to the bottom seven of nine,” Wells Fargo analysts said.

Some new energy issues remained better than issuance as the year closed.

Dominion Energy Gas Holdings, LLC’s 3% senior notes due Nov. 15, 2029 (Baa1/BBB+/BBB+) traded in the 118 bps bid area on Dec. 17, tighter than where the issue was seen at 124 bps bid on Dec. 10, according to a market source.

The Richmond, Va.-based natural gas company sold $600 million of the 10-year notes on Nov. 18 at a Treasuries plus 123 bps spread.

AbbVie, Bristol-Myers strong

Biopharmaceutical bonds priced in two of the year’s biggest deals were ending the year much tighter than issuance.

AbbVie Inc. priced a $30 billion 10-tranche Rule 144A and Regulation S private offering of senior notes (Baa2/A-) on Nov. 12 to fund its acquisition of Allergan plc in the year’s largest bond offering and fourth largest investment-grade deal on record.

AbbVie’s 3.2% notes due Nov. 21, 2029 traded on Dec. 18 at 113 bps bid, according to a market source.

The North Chicago-based biopharmaceutical company sold $5.5 billion of the bonds on Nov. 12 at a Treasuries plus 130 bps spread.

Bristol-Myers Squibb Co.’s senior notes priced in a $19 billion nine-tranche offering in May in another large bond deal in the space also were ending the year better.

The company’s 3.4% senior notes due July 26, 2029 were quoted at 67 bps bid in Dec. 18 secondary trading, a market source said.

The New York-based biopharmaceutical company sold $4 billion of the 10-year notes (A2/A+) on May 7 at a Treasuries plus 105 bps spread.

Communications firm

Elsewhere in the secondary market, Fox Corp.’s 4.709% notes due Jan. 25, 2029 (Baa2/BBB) that priced as part of a $6.8 billion five-part offering at the start of the year traded nearly 80 bps better than where the issue priced in January.

The notes were quoted in mid-December at 112 bps bid.

The New York City mass media company sold $2 billion of the 10-year notes on Jan. 15 at a Treasuries plus 200 bps spread.

Fox priced the deal ahead of its spinoff as a stand-alone company following Walt Disney Co.’s acquisition of 21st Century Fox America, Inc.

Charter Communications, Inc.’s 4.8% senior secured notes due March 1, 2050 (Ba1/BBB-/BBB-) reopened earlier in December were seen nearly 15 bps better by mid-December at the 226 bps bid area, a source said.

Subsidiaries Charter Communications Operating, LLC and Charter Communications Operating Capital Corp. priced a $1.3 billion add-on to the issue on Dec. 2 at a spread of Treasuries plus 240 bps.

The Stamford, Conn.-based broadband communications company originally sold the notes in a $1.5 billion offering on Oct. 15 at a spread of Treasuries plus 260 bps. The total outstanding is now $2.8 billion.

Meanwhile, International Business Machines Corp.’s 3.5% notes due May 15, 2029 that priced in a $20 billion eight-tranche bond offering traded tighter in mid-December at 74 bps bid, a market source said.

The Armonk, N.Y.-based information technology and computer company sold $3.25 billion of the 10-year notes on May 8 at a spread of 105 bps over Treasuries.

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