Dealers Build Bond Inventories Fastest Since ‘07: Credit Markets

Dealers Build Bond Inventories Fastest Since ‘07
Bonds of Amazon were the most actively traded dollar-denominated corporate securities by dealers yesterday, with 106 trades of $1 million or more. Photographer: David Paul Morris/Bloomberg

The biggest banks are boosting their corporate-bond stockpiles at the fastest pace since 2007, supporting a market that’s generating losses for the first time since March and keeping a record volume of debt sales on track.

The 21 primary dealers that trade with the Federal Reserve increased holdings of the debt by $13 billion to $57.8 billion in the five weeks ended Nov. 14, according to Fed data compiled by Bloomberg. Borrowers from Clear Channel Worldwide Holdings Inc. to Abbott Laboratories have sold $119.3 billion of the debt this month, the second-most for the period ever, even as the bonds lose 0.25 percent.

After paring their debt holdings by 75 percent since inventories peaked at $235 billion in 2007, Wall Street banks are reprising their role as market makers heading into the end of an unprecedented year for bond sales. Dealers have increased their holdings to the most since September 2011 as funds that buy the notes report withdrawals.

“When the market has a really good tone and it’s feeling more liquid, the Street is probably more inclined to take down inventory with the expectation that they’ll be able to mark it up and sell it,” Thomas Murphy, who oversees about $26 billion of investment-grade credit at Columbia Management Investment Advisers LLC in Minneapolis, said in a telephone interview. “That can unfortunately backfire for them if the music stops and you get some spread volatility, like we’ve gotten.”

Spreads Widen

The extra yield, or spread, investors demand to own corporate bonds rather than government debentures increased to 242 basis points at the end of last week from this year’s low of 222 basis points on Oct. 18, according to the Bank of America Merrill Lynch U.S. Corporate & High Yield Master index.

Dealers from JPMorgan Chase & Co. to Goldman Sachs Group Inc. are holding the highest level of corporate bonds since Sept. 28, 2011, when holdings reached $60.4 billion, Bloomberg-compiled data show. They have increased their inventories by 29 percent since Oct. 10, the biggest increase since a 31 percent rise in the similar period ended March 14, 2007.

Elsewhere in credit markets, Walt Disney Co., the world’s largest entertainment company, is planning a benchmark bond sale in four parts in its first offering in more than nine months. Theme park operator Six Flags Entertainment Corp. is seeking to amend its bank debt to reduce borrowing costs.

Credit Benchmarks

The Markit CDX North American Investment-Grade index, a credit-default swaps benchmark used to hedge against losses or to speculate on corporate creditworthiness, rose for a second day, climbing 0.3 basis point to 101.1 basis points at 12:12 p.m. in New York. The index reached 111.4 on Nov. 15, the highest level since July 25.

In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings dropped 1.9 to 122.9.

The indexes typically rise as investor confidence deteriorates and fall as it improves. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million.

The U.S. two-year interest-rate swap spread, a measure of stress in credit markets, fell 0.25 basis point to 13 basis points. The measure falls when investors favor assets such as corporate bonds and rises when they seek the perceived safety of government securities.

Amazon Bonds

Bonds of Amazon are the most actively traded dollar-denominated corporate securities by dealers today, with 132 trades of $1 million or more as of 12:09 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

The world’s largest online retailer sold $3 billion of debt yesterday in three parts, tapping the bond market for the first time in more than a decade. Its $1 billion of 1.2 percent, five-year notes were little changed from the issue price, trading at 99.7 cents on the dollar at 11:34 a.m. to yield 61 basis points more than similar-maturity Treasuries, Trace data show.

Disney, the owner of the ABC network and ESPN may sell as soon as today three-year securities to yield about 40 basis points more than similar-maturity Treasuries, five-year notes at a relative yield of about 65 basis points, 10-year securities at about an 85 basis-point spread and 30-year debt at about 100, according to a person familiar with the transaction. Benchmark offerings typically are at least $500 million.

Six Flags

The company last sold debt in February, issuing $1 billion of 1.125 percent, five-year debentures and $400 million of 2.55 percent, 10-year bonds, according to data compiled by Bloomberg.

Six Flags expects to complete any amendment by the end of the year, the Grand Prairie, Texas-based company said today in a regulatory filing.

The company has an $860 million term loan maturing in 2018, Bloomberg data show. The company also has a $200 million revolving credit line and $75 million term debt, each due in 2016, the data show. Under a revolver, money can be borrowed again once it’s repaid; in a term loan, it can’t.

Dealers have bought a net $3.9 billion of corporate bonds from their customers in November, up from $1.1 billion last month and $1.7 billion in September, Trace data show. That compares with net sales of $5.4 billion during the three months ended Aug. 31, according to Trace.

Discouraging Inventory

While banks have been net buyers in the past five weeks, they have reduced their holdings to just 25 percent of the $235.3 billion accumulated in October 2007 as the Dodd-Frank Act’s Volcker Rule in the U.S. seeks to limit risk-taking. They are curtailing the amount of their own money they use to facilitate bond trading after the 27-country Basel Committee on Banking Supervision raised minimum capital requirements in 2010.

“There’s still been a very big decline and it’s permanent because of the regulatory environment that discourages dealers from keeping inventory,” Hans Mikkelsen, a Bank of America credit strategist in New York, said in a telephone interview. “I don’t think that’s changing at all.”

The new rules are being crafted and implemented as the global economy struggles to gain momentum following the worst financial crisis since the Great Depression, which caused $2 trillion of losses and write-downs.

Federal Reserve Chairman Ben S. Bernanke has been trying to galvanize U.S. economic growth by saying the Fed anticipates keeping interest rates at around zero until at least mid-2015 and by buying bonds.

Yield Plunge

The stimulus plans pushed investors into riskier assets, spurring $1.34 trillion of high-yield and investment-grade bond sales this year, already exceeding the record reached in 2009. Since Sept. 19, speculative-grade borrowers have sold $90.4 billion of notes, even as funds that buy the notes reported $3.1 billion of withdrawals, RBS data show.

JPMorgan, Bank of America and Citigroup are leading underwriters of the debt as borrowers seek to lock in yields that plummeted to an unprecedented 2.73 percent for investment-grade notes on Nov. 8 and 6.84 percent for speculative-grade debt on Oct. 18, Bank of America Merrill Lynch index data show. The top-tier of corporate bonds gained 10.1 percent this year, while junk debt has returned 13 percent, according to the data.

“We have had a very sharp upturn of high-yield issuance, with back-to-back record-breaking months in September and October,” said John Lonski, chief economist at Moody’s Capital Markets Group in New York. “That’s perhaps a little bit of a backlog in the ability to distribute.”

Junk Withdrawal

As dealer inventories increased, investors yanked $1.3 billion from high-yield bond funds in the week ended Nov. 14, the most since June, as concern mounted that U.S. lawmakers would be unable to avoid $600 billion in scheduled spending cuts and tax increases by resolving discord over how to manage the nation’s deficit.

Speculative-grade bonds are losing 0.1 percent this month, the first decline since May, Bank of America Merrill Lynch’s U.S. High Yield Master II Index shows.

Banks are “supposed to be in the moving business and not the storage business,” Columbia’s Murphy said. “Whenever volatility picks up, they end up sometimes being stuck in the storage business and that probably makes them uncomfortable.”

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