Bond Hoarders Squelch Trading in Record Issuance: Credit Markets
Corporate-bond trading is failing to keep up with unprecedented issuance, accounting for the lowest proportion of outstanding debt since at least 2005.
Average volumes of bonds changing hands each day this year represent 0.29 percent of the market’s face value, according to data compiled by Bloomberg and Trace, the Financial Industry Regulatory Authority’s bond-price reporting system. That’s down from 0.32 percent in 2011 and 0.5 in 2005.
The drop in trading underscores the complacency among investors who funneled cash into bonds at what Bank of America Corp. strategists in August said were reaching “bubble levels.” The biggest banks, which traditionally have acted as a backstop for the market during slumps, have cut the amount of company bonds they own by 78 percent since the peak in 2007.
“If everyone headed to the exits at once, that could really create a violent selloff,” said Anthony Valeri, a market strategist in San Diego at LPL Financial, which oversees $350 billion of assets. “Liquidity is one of my bigger fears for 2013. I don’t see the dealer community stepping up to slow the downfall.”
While the average daily bond-trading volume has risen 8 percent from last year, the size of the market has swelled by 18 percent to approach $6 trillion, Trace and Bloomberg data show.
The biggest banks are reducing the amount of their own money they use to facilitate bond trading as the Dodd-Frank Act in the U.S. seeks to limit risk-taking. The 21 primary dealers that trade with the Federal Reserve have cut their company-debt holdings to $51.5 billion as of Nov. 28, down from $235 billion in October 2007, Fed data show, after the 27-country Basel Committee on Banking Supervision raised minimum capital requirements in 2010.
“We’re going to be in a channel of low liquidity for a prolonged period of time,” said Jason Rosiak, the head of portfolio management at Pacific Asset Management, the Newport Beach, California-based affiliate of Pacific Life Insurance Co. “We may get back a little bit more liquidity, but it will be nothing like what it was during the go-go days.”
Elsewhere in credit markets, Crown Castle International Corp., the provider of infrastructure for wireless communications, is planning to issue $1.5 billion of senior secured debt to help fund a tender offer. Abu Dhabi National Energy Co. (TAQA), the state-controlled power-and-oil company known as Taqa, is said to have increased a revolving credit facility by 25 percent to $2.5 billion on lender demand for the deal.
The cost of protecting corporate bonds from default in the U.S. fell to the lowest level in more than seven weeks. The Markit CDX North American Investment Grade Index, a credit- default swaps benchmark used to hedge against losses or to speculate on creditworthiness, dropped 2.7 basis points to a mid-price of 92.8 basis points as of 11:31 a.m. in New York, the least since Oct. 18, according to prices compiled by Bloomberg.
The indexes typically fall as investor confidence improves and rise as it deteriorates. 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 of debt.
The U.S. two-year interest-rate swap spread, a measure of debt-market stress, fell 0.81 basis point to 10.94 basis points. The gauge narrows when investors favor assets such as corporate bonds and widens when they seek the perceived safety of government securities.
Crown Castle is planning to sell $500 million of notes due in 2017 and $1 billion of bonds maturing in 2023 through its CC Holdings GS V LLC unit, it said today in a statement. Proceeds will fund a tender offer for its 7.75 percent senior secured securities due 2017, and to redeem any of the debt that remains outstanding. The rest of the proceeds will go toward a tender for its 9 percent debentures due in 2015, the company said.
Crown Castle last sold debt in October, issuing $1.65 billion of 5.25 percent, senior unsecured notes due in January 2023 to yield 363 basis points more than similar-maturity Treasuries, according to data compiled by Bloomberg.
Taqa’s facility comprises three- and five-year credit lines and is due to sign this week, according to three people familiar with the situation, who asked not to be named because the terms are private. Sixteen banks joined coordinator Bank of Tokyo- Mitsubishi UFJ Ltd. and the nine other bookrunners in syndication, two of the people said. Taqa originally sought $2 billion, according to data compiled by Bloomberg.
The shorter-dated portion pays interest at 75 basis points more than benchmark rates and the longer piece has a margin of 1 percentage point more, the people said. The debt will replace a $2 billion credit facility maturing in December 2013 that paid a margin of 100 basis points, the data show.
Bonds of Caracas-based Petroleos de Venezuela, or PDVSA, are the most actively traded dollar-denominated corporate securities by dealers for a second day, with 82 trades of $1 million or more as of 11:27 a.m. in New York, Trace data show.
PDVSA’s $6.15 billion of 8.5 percent bonds due in November 2017 have surged 9.6 cents to 98.6 cents on the dollar in the past month, with the yield falling to 8.86 percent from 11.5, amid speculation President Hugo Chavez will be unable to complete his third term.
Chavez traveled to Cuba for more surgery after urging Venezuelans to vote for Vice President Nicolas Maduro if he is unable to remain in office, marking the first time he’s indicated who he wants to succeed him since falling ill in June 2011. Speculation his health was deteriorating following his re- election mounted after he spent 12 days in Cuba as part of a 21- day absence from public view that ended Dec. 7.
Corporate bond trading volumes are declining as the biggest banks reduce their balance sheets and eliminate more than 300,000 financial industry jobs in the past two years.
“The broker-dealers are using less capital-at-risk in their trading platforms due to regulation and human capital,” Pacific Asset’s Rosiak said. “When you’ve lost a significant amount of human capital over the last five years, you’re less apt to empower people to take on significant amounts of risk.”
An average of $16.93 billion of investment-grade and high- yield bonds traded every day this year as the value of outstanding corporate bonds rose to $5.72 trillion, according to Finra and Bank of America Merrill Lynch index data. That compares with last year’s average daily trading volume of $15.73 billion with $4.86 trillion of debt outstanding, the data show.
Much less of the corporate bond market is held by hedge funds, “and where it is held by hedge funds, there is less leverage,” or borrowed money to fund the trades, contributing to lower turnover, said Ashish Shah, the head of global credit investment at New York-based AllianceBernstein LP, which oversees $245 billion in fixed-income assets.
At the same time, he said, corporate pensions are buying investment-grade company debt to match their assets with their liabilities, giving the market generally more stable buyers.
Investors are holding onto the debt as U.S. bond funds receive a record $452 billion this year, causing yields on investment-grade securities to drop to an unprecedented 2.73 percent on Nov. 8, EPFR Global and Bank of America Merrill Lynch index data show.
Concerns the slowing economy will suppress company earnings and trigger an increase in defaults “have been steamrolled by the renewed push to reach for yield,” Oleg Melentyev, a New York-based credit strategist at Bank of America, said in an Aug. 14 report. Flows into credit funds “in some respect are reaching bubble levels, never before breached in history,” he wrote.
Dollar-denominated corporate bond issuance of $1.4 trillion this year is up from $1.13 billion in 2011 and surpassed the previous record of $1.24 billion in 2009, Bloomberg data show.
Corporate bonds have returned 11.2 percent this year, the most since gaining 26 percent in 2009, Bank of America Merrill Lynch index data show.
“A lot of the new deals just get put away and then people, quite frankly, hoard those bonds,” LPL’s Valeri said. “So you don’t see a lot of trading, partly because of that, and the other aspect being the regulatory environment.”
Investors will continue to be willing to pay a premium for liquidity, or the ability to trade bonds easily, and that demand may intensify, Barclays Plc strategists led by Jeffrey Meli wrote in their global credit outlook for 2013 titled “A Good Bond is Hard to Find.”
While the trend of depressed market turnover persisted from 2011, “the dominant issue remains concentration of those volumes,” they wrote in the note dated Dec. 7.
Half of investment-grade trading volume was in the bonds of 34 issuers, and 48 tickers in speculative-grade debt, said the strategists, who attributed it in part to the rise of fixed income exchange-traded funds that track “narrow benchmarks.” Speculative-grade bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- at Standard & Poor’s.
“Unfortunately, in the near future, we do not expect an increase in dealer balance sheets, which means that dealers are likely to use their limited inventories for the most liquid securities,” they wrote. “Investors that wish to implement short-term market views will need to do so through the most liquid parts of the market.”
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