7 capital markets trends revisited mid-year 2012
Kimco’s recent offer of $225 million of perpetual preferred stock provides a clear indication of the state of the capital markets these days.
We were able to get the deal done at 5.50 percent, which is the lowest coupon ever issued by a REIT, and believed to be the lowest coupon ever for a perpetual preferred security of any kind. The issue was snapped up within three hours, and our bankers told us there was demand for much more.
In their thirst for yield above treasuries and flight to quality, investors are willing to accept lower and lower yields from investment-grade credits, such as Kimco. And there certainly is no shortage of securities for them to invest in. The markets these days are flooded with capital, including significant amounts of money being put out by the CMBS and bank markets.
Given the slowing U.S. economy, the uncertainty in Europe, and the looming fiscal cliff in the U.S., among other worries, most investors would have predicted a slow down or a pull back in lending, but that hasn’t happened. Indeed, it’s just the opposite, as demand for investment-grade debt has never been higher.
In that context, let’s revisit the seven capital market trends I wrote about back in March, and see how they’re impacting Kimco and other real estate investors today.
1. Spreads will continue to compress in the unsecured bond market. This, indeed, has happened. Back in March, we were looking at spreads in this market of about 250 basis points over 10-year treasuries. Since then, spreads have tightened quite a bit. Although we haven’t issued bonds recently, we could probably go into the market today with a spread of about 170 to 180 basis points. With 10-year treasuries currently at about 1.5 percent, that means we could issue debt at about 3.25 percent, a pretty attractive rate. Normally when you see treasury yields dropping so much, you would expect spreads to go the other way. They haven’t. So as a borrower, as a capital user, these are pretty positive signs. The unsecured bond market remains wide open for investment-grade credits, and you’re continuing to see historic, record-low coupons coming one after the other.
2. U.S. corporate bond sales in 2012 will continue to rebound. If you need any evidence of this, just look at the corporate bond activity last month — the busiest July for this market since 2009. Anheuser-Busch InBev topped the list of issuers with its $7.5 billion offering on July 11, part of the $277.8 billion of corporate bonds issued last month. The demand for investment-grade debt remains very strong, even as yields reach record lows. Indeed, IBM achieved a record-low coupon of 1.875 percent on its 10-year, $1 billion bond offering on July 25, as a string of companies, from Unilever to Texas Instruments, look to borrow at all-time low rates. Yields on investment-grade bonds dropped to around 3 percent, touching an historic bottom. For investors, it’s all about a flight to quality, seeking a safe haven, and locking in a yield that’s above treasuries. Most analysts predict continued growth in this market through 2012.
3. More U.S. banks will repair their balance sheets and improve their liquidity positions. Banks continue to scramble to repair their balance sheets, cut debt, and ready themselves for new regulations aimed at ensuring higher capital cushions. That includes a requirement to have more tier-one capital under Basel III regulations. With trust preferred securities (TruPs) essentially having lost their tier-one status, banks will be redeeming these securities by issuing tier-one-eligible non-cumulative perpetual preferred stock at lower coupons. As a result of the expected redemptions, investors will need to find other securities in which to reinvest their funds. I think that’s part of what helped us with our recent perpetual preferred issuance. We were at the front end of what is going to be a tidal wave of new issuances and redemptions. The market, in terms of rate, has backed up a little since we completed our offering, because we’re starting to see so much flow coming in. But the market still is in incredible shape. I think there’s going to be billions of dollars of perpetual preferred stock issued because we’re at interest-rate levels that, for permanent capital, no one has ever seen before.
4. The commercial mortgage-backed securities (CMBS) market will be available in 2012. The CMBS market has been much more active than it was a year ago. According to a recent Bloomberg report, total issuances this year are around $17 billion, compared with $28 billion for all of 2011. Predictions are that $35 billion to $45 billion worth of deals will get done in 2012 — still a far cry from the record $232 billion in commercial-mortgage bonds that were sold in 2007, but a substantial increase over last year. And they’re getting done at levels that, as a borrower, are pretty appealing. Relative yields on top-ranked bonds linked to commercial mortgages recently dropped to 180 basis points above treasuries, down from 261 basis points at the end of last year. On-book bank lenders and insurance companies that are awash in capital are feeding the demand as they look for ways to get yield. For them, real estate lending, even in the mid-to-high three’s for 10-year deals, is better than investing in a treasury at 1.5 percent.
5. It’s uncertain how long the spread differential between the bank and unsecured bond markets will last. Our view back in March was that spreads would tighten, and that certainly has come to pass. In April, Kimco closed on a $400 million unsecured term loan with an interest rate at LIBOR plus 105 basis points. We decided to go to the bank market because the spread on five-year unsecured paper was 100 to 125 basis points higher than what we were able to get from the banks at that time. There was a real disconnect between the two markets back then, and we were able to take advantage of it. In the last 45 days or so, we’ve finally seen spreads really begin to tighten, so that gap today is about 50 basis points. I think the bond market has figured out the bank market wasn’t really all that far off. So, as a borrower, that’s another encouraging sign.
6. Equity markets should remain open in 2012. We still see the common equity markets being available for companies that plan a fairly quick, accretive use of proceeds. Kimco, for its part, has no current plans to raise capital through common equity in the near term. We continue to raise a fair amount of capital internally through Kimco’s capital recycling program, as we sell both non-retail assets and non-strategic retail properties in our quest to upgrade the overall quality of our portfolio. So, there really is no need for further common equity as this point. Instead, we’re tapping into other aspects of the capital markets to help reduce our overall cost of capital going forward.
7. European markets hang in the balance. Back in March, the big question on everyone’s mind was, what’s going to happen to Greece? While that country still struggles with its financial reforms, the focus has shifted to the far bigger economies of Spain and Italy, which are facing sovereign debt crises as well. Eurozone leaders have pledged to keep the union afloat, and Mario Draghi, head of the European Central Bank, has pledged to do “whatever it takes” to preserve the euro. Even though Germany appears to be firm in its opposition to the ECB buying bonds or acting as a lender of last resort, I think we might see some euro bonds in the future. The U.S. was able to thaw its frozen credit markets by flooding them with liquidity, and I think that’s what’s going to eventually happen in Europe. The Eurozone has an enormous amount of work to do, but with the right political resolve, it will figure out how to hold it together, and I think Germany will be a significant player in that.
As for Kimco, we’re in great shape. We have raised more than $1.5 billion of new capital so far this year from the unsecured bank market, mortgage market (both CMBS and on-book lenders), and perpetual preferred equity market.
Our balance sheet metrics are strong. We’ve made a significant improvement in our fixed-charge coverage ratio, now at 2.6 times. Our net-debt-to-recurring-EBITDA ratio stands at 5.6 times, down from 6.0 times at the end of last year, and 8.3 times more than two years ago.
We have more than $2 billion of liquidity, including $380 million of cash on hand and more than $1.7 billion in our revolving credit facility, that’s ready to use to take advantage of opportunities within the market.
Through our recent capital raises, we’ve already prefunded all of our near-term debt maturities. With our $400 million term loan that closed in April, we have prefunded the $200 million bond issue that is coming due in November, as well as the $100 million that’s due in January 2013.
We’ve also prefunded the anticipated redemption of our $460 million, 7.75 percent perpetual preferred issuance, due in October, with a new $400 million, 6 percent preferred issuance, completed in March.
And with the proceeds from our most recent deal, our $225 million perpetual preferred issuance at 5.5 percent, we will be able to redeem our $175 million, 6.65 percent preferred issuance on August 15. Once these redemptions are completed, we will save approximately $11 million annually, and further reduce our fixed-charge costs.
Overall, the capital markets continue to function well, with ample capital available for investment-grade issuers at record-low rates, as investors continue to chase yield and safety. In short, it’s a great time to be a borrower if you’re a high-quality credit like Kimco, and we have taken full advantage of that.