7 capital market trends to watch in 2012

Posted by: Glenn Cohen Glenn Cohen
on March 14, 2012

Several factors are converging in 2012 to help the capital markets stabilize after experiencing significant volatility last year. Although some issues remain uncertain — particularly Europe’s financial struggles — several areas of the market are rebounding and gaining momentum. Here are seven capital market trends Kimco is watching in 2012, and how we see them impacting retail real estate throughout the year.

1. Spreads will continue to compress in the unsecured bond market. The unsecured bond market experienced an enormous amount of volatility in 2011. Spreads compressed significantly in the first half of the year, then widened as concerns about Europe’s debt crisis mounted — in Kimco’s case to in excess of 300 basis points over 10-year paper. The bond market was extremely weak over the summer, until late September when Deutsche Bank sold 1.5 billion euros in unsecured bonds. Since then, the market has been open. Volatility remains, although we’ve seen spreads start to compress again. Even at spreads of 200-250 basis points, with the 10-year bond trading somewhere around 2 percent, you’re still looking at 10-year financing in the low 4 percent area for a company like ours. That’s pretty attractive debt that is easy to access, so the unsecured bond market is clearly open and available. As we look into 2012, we expect to see further spread compression as we get more clarity around the European financial crisis and U.S. economic recovery. This should create opportunity for all REITs to opportunistically tap the unsecured bond market.

2. U.S. corporate bond sales in 2012 will continue to rebound. Issuers are continuing to lock in decreasing yields on investment-grade corporate bonds, which have fallen to 3.54 percent, near the record low 3.45 percent reached August 4. IBM, Procter & Gamble, and Petroleo Brasileiro SA led January with $10.5 billion of offerings combined, while AT&T and Freeport led February with $3 billion each of offerings. In addition, investors are more confident that Europe’s financial struggles won’t derail U.S. economic recovery. And the Federal Open Market Committee announced last month it will keep short-term interest rates at 0.0 percent to 0.25 percent through at least late 2014. These factors are making corporate bond yields attractive, and indicate the market for new corporate bond issues should remain quite active in 2012.

3. More U.S. banks will repair their balance sheets and improve their liquidity positions. Capital is increasingly available within the commercial banking system for companies with solid credit. Kimco’s new $1.75 billion unsecured revolving credit facility is an example. We had decided to renew our $1.5 billion unsecured revolving U.S. credit facility a year early. Demand was tremendous when we went to market in summer 2011 looking for a five-year facility. We quickly had commitments from 28 banks totaling over $2.8 billion — $1 billion more than we had requested. This included commitments from European lenders, including Deutsche Bank, UBS, and RBS, all of which made fairly large commitments to our revolver. On the pricing front, we negotiated a borrowing spread of 105 basis points over LIBOR, one of the tightest spreads in the industry, and about 100 basis points tighter than spreads 12 months prior. So for solid credits, there is the ability to access significant amounts of medium-term capital at very low costs.

4. The commercial mortgage-backed securities (CMBS) market will be available in 2012. Insurance companies were a great source of financing for the right properties in 2011. We’re cautiously optimistic the CMBS market will be open in 2012, with many insurance companies having a lot of money to put to work. Remember, the market overheated by the summer of 2011, and then closed down for a little while. But securitizations are getting done, and we’re starting to see deal flow. In addition, banks have opened up. With Treasuries as low as they are — yields on 10-year Treasury notes remain around 2 percent — there is clearly access to capital within the mortgage market.

5. It’s uncertain how long the spread differential between the bank and unsecured bond markets will last. The spreads in the bank market are significantly tighter than spreads in the unsecured bond market. For instance, for a five-year unsecured paper, the spread differential between a bank and an unsecured bond loan is between 100 and 150 basis points. You would think after all the trouble banks have endured, there wouldn’t be that much difference. And if the unsecured bond market ostensibly has so much capital available, maybe the positions would be reversed. Nevertheless, this is an opportunity to take advantage of the disconnect between the bank and the bond market today — while it lasts.

6. Equity markets should remain open in 2012. The equity markets are open for companies with stories that include a fairly quick, accretive use of proceeds. So we’re more cautious about the equity markets going forward. Kimco’s capital plan as we continue into 2012 is to avoid the common equity markets, and instead look at our assets where we can recycle capital, sell assets we want to move — particularly those outside the retail sector –, and use those proceeds to further our investment in our core shopping center business.

7. European markets hang in the balance. Naturally, a big question is: What will happen in Europe and how will it affect banks and economies worldwide? Market sentiment has vacillated in recent weeks as Greece struggles to come to an agreement on financial reforms. A Greek default will impact bond issuances in sovereign countries, including Italy, Spain, and Portugal. A liquidity injection by the European Central Bank could help stabilize the countries. Although Europe is not moving as quickly as some would like, the issues are clearly on the table and some level of resolution will happen during 2012. If there is a resolution in Europe with which people can get comfortable, we believe risk appetites in the U.S. credit market will improve.

The capital markets operated fairly well through 2011, and we expect to see them remain open as we continue into 2012. We feel very good about our balance sheet today, and are squarely focused on continuing to improve our balance sheet metrics, including net debt to recurring EBITDA and fixed charge coverage. Two-and-a-half years ago, Kimco’s net debt to recurring EBITDA was more than 8.3 times on a recurring basis. Today, it’s around six times.

Looking ahead, we have $460 million of perpetual preferred stock with a coupon of 7.75 percent that will be callable in October. We recently announced the new issuance of $400 million of perpetual preferred stock at a coupon of 6 percent. We will use the proceeds from this offering partially towards calling the higher coupon perpetual preferred stock when it becomes available. This is a savings of 175 basis points, or almost 2 cents per share on an FFO basis.

We also have approximately $300 million of bonds that will mature between late 2012 and January 2013. Depending on spread compression, there’s also an opportunity to pre-fund some of those maturing bonds to lower our overall capital cost and improve our coverage ratios.


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