Bond Trade Cheapest Since ’07 Hits Record Amount: Credit Markets
Investors are paying the least in six years to trade U.S. corporate bonds as they transact more frequently than ever, adapting to a Wall Street where dealers commit less money to facilitate buying and selling.
Corporate-bond buyers are paying an average 12 basis points, or 0.12 percentage point, in each trade, down from as much as 56 basis points during the height of the financial crisis in 2008, according to Barclays Plc data. Volumes as a proportion of the total market are starting to climb for the first time in three years, with a record daily average of $12.8 billion traded in 2013, Financial Industry Regulatory Authority and Bank of America Merrill Lynch index data show.
Five years after a credit seizure that ushered in stricter banking rules and prompted dealers to reduce the money they allotted to trade, the market is working through the unintended consequences of the regulations. Investors are trading on electronic systems at a record pace and funneling the business through a greater number of brokers as they seek an edge in securities that are headed for the first annual loss since 2008 after gaining 56 percent the previous four years.
“It is easier to get things done,” said Jon Duensing, a money manager at Amundi Smith Breeden, the U.S. unit of the French asset-manager Amundi that oversees about $1 trillion. “We’re still a ways away from where markets were prior to the financial crisis, but certainly stepping in the right direction.”
Investors also are transacting more frequently in smaller chunks of debt after declining dealer inventories lengthened the time it took to execute trades of $5 million or more, according to Barclays strategists and data from Trace, Finra’s bond-price reporting system. As transactions increased, the average size of investment-grade debt trades fell to $501,635 in the three months ended Sept. 30 from $815,828 in 2007, Trace data show.
Trading volumes are accelerating after three years of failing to keep pace with the market’s expansion, soaring 12.6 percent since Sept. 30 to a daily average of $13.2 billion from the $11.7 billion in the same period last year, Finra data show. That’s greater than the 9.8 percent increase in outstanding investment-grade bonds, according to the Bank of America Merrill Lynch U.S. Corporate Index.
“It’s become relatively easier to trade a broader part of the universe than it was two years ago,” said Alex Gennis, a credit strategist at Barclays (BARC) in New York. “Transaction costs are as low as they’ve been since the financial crisis.”
A measure of those costs known as the bid-ask spread, or the difference between the prices at which dealers will buy and sell the same bond, shrunk to 12 basis points at the end of November from 17 basis points a year ago, Barclays data show. That gap has declined as the extra yield investors demand to own the securities instead of similar-maturity Treasuries fell 20 basis points this year to a more than six-year low of 134 basis points, the Bank of America Merrill Lynch index data show.
Bond investors who traditionally executed trades over the telephone are turning to computer screens that allow them to seek competitive bids. They conducted 14.9 percent of dollar-denominated, investment-grade bond trades on MarketAxess Holding Inc.’s system in the three months ended Sept. 30, up from 12.5 percent a year earlier, the New York-based company said in an Oct. 23 presentation on its website.
Electronic volumes reached an unprecedented $406.3 billion in the first 11 months of the year, according to data from the firm, which estimates it captures about 90 percent of all electronic transactions in the securities.
“The market is currently sending mixed signals about liquidity,” McKinsey & Co. consultants led by Roger Rudisuli said in a report this month. “If liquidity gets worse, that may accelerate the slow but steady migration toward e-trading.”
The recent increase in all trading activity in investment-grade bonds contrasts with a 1.3 percent drop in average daily trading in the three years after 2009 to $11.6 billion, Trace data show. During the same period, the volume of outstanding bonds included in the Bank of America Merrill Lynch index surged 40 percent to $3.97 trillion.
Bond-trading costs soared in 2008 as spiraling mortgage-debt values triggered the collapse of Lehman Brothers Holdings Inc. and caused more than $2 trillion of writedowns and credit losses globally. The seizure led to tougher global banking rules from the Basel Committee on Banking Supervision and the U.S. Dodd-Frank Act, an overhaul of financial regulation that included the so-called Volcker Rule intended to curb the risk lenders take with their own money.
Primary dealers that trade directly with the Federal Reserve cut their holdings of corporate bonds by 76 percent from a peak of $235 billion in 2007 to $56 billion at the end of March, Fed data show. After the central bank changed the way it reported the data on April 3, net investment-grade bond holdings fell as much as 52 percent, to a low of $5.4 billion on Aug. 28. They have since risen to $15.5 billion on Dec. 4.
Dealers traditionally have bought larger pools of bonds that they could sell over a longer period of time at a profit, cushioning prices from bigger swings and making it easier for investors to shift positions quickly. The strategy was made costlier by regulations that increased the amount of capital that banks need to hold against securities with higher probabilities of default.
Money managers who used an average of seven dealers for the biggest purchases and sales of investment-grade securities in 2009 now say they need nine or 10, according to Stamford, Connecticut-based financial advisory firm Greenwich Associates.
“The market has definitely adapted to dealers having less of a role in providing liquidity,” said David Simmons, a senior corporate-bond trader at Loomis Sayles & Co., the Boston-based investment firm that manages $193.5 billion of assets. “Our portfolio managers understand that it will take longer to trade bonds than it used to.”
Even as bank balance sheets contracted, bond managers’ holdings swelled as the Fed’s easy money policies suppress borrowing costs, fueling record volumes of corporate debt issuance and pushing investors into riskier assets. Investment-grade bonds are losing 1.5 percent this year as buyers gird for the central bank to start curtailing $85 billion of monthly purchases that helped push the average yield on the debt to a record-low 2.65 percent in May.
Credit hedge funds have received $20.6 billion in the first nine months of the year, with their total assets under management swelling to an unprecedented $666.5 billion, according to Chicago-based Hedge Fund Research Inc. Non-traditional bond funds attracted a record $51.5 billion this year through November, Morningstar Inc. data show.
Right now, “it’s easier to find the other side of a trade,” said Steve Antczak, a credit strategist at Citigroup Inc. in New York. “You are seeing a few more players step into credit and try to do different things. It’s different from years past.”
Elsewhere in credit markets, U.S. interest-rate swap spreads plunged to the narrowest on record as traders speculate the Fed may take steps to lower money-market rates at today’s policy meeting. Bonds of Toys “R” Us Inc. dropped after the retailer said its net loss widened in the three months ended Nov. 2 as domestic comparable-store sales dropped 5.2 percent.
The difference between the two-year swap rate and the comparable-maturity Treasury note yield, known as the swap spread, dropped to as low as 5 basis points, according to Bloomberg data compiled since 1988. The gap, in part a gauge of investors’ perceptions of U.S. banking-sector credit risk, is derived from expectations for the dollar London interbank offered rate and the direction of short-term government debt yields. The spread was as much as 24.6 basis points on June 24.
Fed officials have cited cutting the interest paid to banks on excess reserves, known as the IOER, as a method that could be used to convince investors that tapering its bond purchases isn’t the same as tightening monetary policy. Lowering the rate, now at 0.25 percent, is among “ideas that are still in play” as the central bank seeks to improve the way it communicates the outlook for interest rates, Atlanta Fed President Dennis Lockhart said on Dec. 5.
The cost to protect against losses on U.S. corporate bonds was little changed. The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark used to hedge against losses or to speculate on creditworthiness, fell 0.4 basis point to 69.6 basis points as of 11:10 a.m. in New York, according to prices compiled by Bloomberg. The gauge reached a more than six-year low of 67.3 on Dec. 9.
In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings decreased 0.7 to 77.1.
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.
Toys “R” Us’s $725 million of 8.5 percent notes due in December 2017 fell 1.7 cents to 102.25 cents on the dollar at 10:07 a.m. in New York to yield 7.23 percent, Trace prices show. The bonds are trading at the lowest level since June 2012.
The Wayne, New Jersey-based retailer said in a statement yesterday that its net loss in the fiscal third quarter widened to $605 million from $105 million a year earlier.
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