April 02, 2020Institutional Investment Management

I want to share something important that is happening in the investment grade corporate credit market. I track the option adjusted spread (OAS) which is essentially the additional yield the investor receives versus a risk-free Treasury security. Prior to the COVID outbreak, the OAS for the investment grade corporate bond index was 102 basis points. A month later, the OAS had increased to 401 bps. It currently stands at 305 bps. In December of 2008, the index reached 651 bps.

The image below shows the credit spread for a 30-year maturity bond issued by Intel on March 20th. Intel is rate A1/A+ and is considered an excellent credit. This bond was issued at a spread of 310 basis points (over the 30-year T bond yield) and was priced at 99.889. The coupon is 4.75%. Ten days later, the bond was trading at a yield of 3.00% or a price of 134! This price increased 34% in 10 days. If I was the CFO at Intel, I would be outraged at the underwriters for issuing my debt at a yield well-above what was necessary as evidenced by the trading pattern after issuance. The underwriters price these new issues at levels where they know they will get 3 or 4 times more orders than bonds because they don’t want any bonds to go unsold. They collect their fee and move on. Intel ends up paying a much higher interest rate than necessary for the next 30 years.

New issuance has been fast and furious but levels seem to be much higher than what is necessary.