# Filling up

## general motors

Debt issuers in the US greedily tapped the market in the first half of 2003, making the most of cheap credit and willing investors.

Positive sentiment on lower-rated credits, boosted by the first-quarter earnings season, ensured that the momentum that had built up in high-yield debt continued. Borrowers pushed out an average of $13.6 billion of bonds per week into the US market in the three months to the end of June, the highest quarterly level in two years. However the loudest voice at the bar was heard just before closing time, when GM ordered a$13 billion cocktail that drew gasps from fellow revelers. Despite having already racked up a tab of more than $210 billion, GM was still served – in fact its cup was filled to overflowing, with 16 investment banks fielding orders for some$30 billion.

By the time the order book closed on June 26, GM had amassed a total of $17.6 billion in notes and convertible bonds – the largest deal ever brought by a US issuer. Nonetheless, the company was only able to command such volume by offering investors a spread some 225 basis points wider than was available elsewhere in the market. The issue was prompted by GM’s need to plug a$25.4 billion hole in its pension funds, a deficit the equity bear market caused to double in size during 2002. The question now is, has GM drunk the bar dry or is there more in the tap? And will the bar stay open at current prices?

Early indications are positive, says CSFB auto credit analyst Kevin Morley. “The bonds are trading well. Secondary trading has slowed down a little bit as we have absorbed such a massive amount of bonds, and at one point there were more sellers than buyers and spreads moved out, but I think they have settled in quite nicely,” he says.

In fact market watchers say there have been no major repercussions from the deal, whether in the auto sector or the general market. Corporate spreads are tighter now than when the GM deal was being done, while the yield kicker on the GM deal is still turning heads.

“We are favorably inclined to overweight the auto sector in general, particularly when you look at their spreads compared to other triple-Bs; they are still quite generous considering how much rallying has occurred in almost every other sector, and wider spreads will always get someone’s attention,” says Morley.

This attitude seems widespread in a market that was already apparently full up on autos paper but somehow managed to find room to accommodate another issue from GM. “There is appetite for paper, but it’s one of the conundrums for auto paper in general that everyone owns it already. In certain instances we had customers that couldn’t participate in this deal because they’re at their limit already. But at various spread levels there is always demand,” says Morley.

Jeffrey Rosenberg, head of the credit strategy research group at Bank of America, says: “If you were to ask any of the participants during the previous three months whether they thought GM would be able to get $13 billion worth of issuance out, they all would have said that everybody’s already full on autos and the name. But there is an incredible elasticity of demand that is extremely difficult to assess.” He adds: “When you have an issue of this size, the kneejerk reaction is to ask how you can get it out, and the answer is price. There is a market clearing price, and 375 basis points over Treasury, compared to the average spread in the investment-grade market at about that time of 150 basis points, tells you the price was right and there was enough compensation.” However the deal did lead auto parts manufacturer Delphi Corp. to delay a$300 million-plus issue of mortgage-backed securities planned for the end of the second quarter, saying that the GM issue had saturated demand for auto investments.

GM is the fourth largest issuer in both the Lehman Brothers and Merrill Lynch corporate bond indices, while rival Ford, the most widely held issuer of corporate bonds, makes up 2.8% of the Lehman index.

Jack Davis, head of credit research at Schroders, says GM’s index weighting would have boosted demand for the issue as some uncertain investors sought the security of benchmark tracking.

“There is a tendency in times of uncertainty when interest rates are low and we might be in turnaround to stick close to the index and perhaps not make quite as big bets on individual credits. So the fact that GM was going to grow in the index because of this issue might have brought in some marginal buyers,” he says. “I don’t think many people would have said they couldn’t tolerate the increased tracking error caused by not buying this deal, but a big deal does create its own momentum.”

Holly Fullam, credit analyst vice-president at Schroders, says GM’s market timing was a key factor in the success of the deal. “I think GM were brilliant tacticians when it came to the timing and pricing of this issue,” she says. “They did it before the July 4 weekend, and at a time when we had an all-time low in interest rates. They also priced it right: they upsized the deal and the pricing was still very attractive for investors.”

Fullam adds: “When I first heard of the deal I thought ‘Oh no, this is going to strangle the market, it’s too much for them to take.’ But from my portfolio managers’ point of view, this was the right deal at the right time.”

Mark Howard, global credit strategist at Lehman Brothers, says there was an element of surprise in both the size of the issue and GM’s plans for the proceeds. “But once that surprise wore off, as evidenced by the performance of the bonds since then, I think it shows the credit markets are in pretty good shape, and the ability to absorb a deal that size in an out-of-favor sector like the autos at the mid-point of the year actually makes me feel pretty good about the market,” he says.

Still, Howard adds price is the key issue here, with new paper needing to be seasoned with above-market yields in order to entice investor appetite.

“The GM deal served to re-price the broader auto basis at a meaningfully wider spread level such that investors felt they were being fairly compensated for the incremental supply,” he says. “Since then it has tightened rather favorably, so I think that investors do feel generally comfortable with their auto exposures. All things being equal, if there was incremental supply, whether from GM, Ford or Daimler, there would be an appetite at the right price.”

Few, however, expect a repeat performance, either from within the autos sector or anywhere else, for at least the remainder of the year. Ford, whose spread widened in anticipation of issuance after the GM deal was flagged, was forced to announce it had no plans to come to market, despite having its own pensions deficit of \$16.4 billion.

The fact is, despite the interest shown in US corporate pension deficits, nobody is in as bad a shape as GM was before the bond deal. Indeed, many unfunded pension liabilities are expected to become funded merely through an upturn in the equities cycle.

Howard underlines the singular nature of the rationale for the GM deal. “As corporate bond borrowers go, the GM trade was genuinely unique in that they are now the second or third largest borrower and they had a unique pension problem in terms of magnitude,” he says. “There is no other corporate globally that has that type of concern. So their bond issuance, which was designed to immunize that problem, was really not reflective of excess or non-excess in the corporate market.”

Bank of America’s Rosenberg also says it is difficult to ascribe market-defining characteristics to just one issue, record-breaking or not. “I wouldn’t draw much of a market-leading signal from it. The issue was positively received by the market, which illustrated the demand for yield, and I think that is the most important lesson,” he says.

While some pundits have characterized the GM deal as the last straw for the bond bull market, Rosenberg says the subsequent performance of spreads suggests otherwise.

“I don’t think it was necessarily the high point,” he says. “We have been through quite a rally in the market to date, most of which was priced in well before GM’s issuance and has since continued.”

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