Evidence that credit markets are thawing.
Corporate bond trading in the US is rising to the highest in two years, adding to evidence that credit markets are thawing even with stocks off to their worst start since the 1920s as the recession deepens.
An average $17.1 billion of corporate bonds traded daily this month, compared with $17.7 billion in January, according to the Financial Industry Regulatory Authority. The business is up from last year’s low of $9.4 billion in August and reached the highest level since February 2007, Finra data show.
“We saw just dramatic increases in our corporate business,” said Dan Leland, head of taxable capital markets at Dallas-based Southwest Securities, a unit of SWS Group Inc. “One of the last places you can get an attractive yield with relative safety is in the corporate arena. The equity markets just continue to deteriorate.”
Corporate bond trading is accelerating after the recession pushed investment-grade yields to 9.3 per cent in October, the highest in 17 years, according to data compiled by Merrill Lynch & Co. Investors are betting yields are high enough to compensate for defaults that Moody’s Investors Service forecast will rise to 16.4 per cent by November, the highest since the Great Depression and about three times the current rate.
Yields fell as low as 7.38 per cent this week, according to Merrill Lynch’s US Corporate Master index. Speculative-grade yields declined to 18 per cent from a record high of 22.7 per cent in December.
Record Sales
An increase in corporate bond sales also fuelled trading. Borrowers sold $223 billion of corporate bonds this year, up 61 per cent from the same period in 2008 and 43 per cent ahead of the record pace set in 2007, Bloomberg data show.
High-yield, high-risk, or junk, bond sales increased to $5.35 billion In January, the most since June. Bonds rated less than Baa3 by Moody’s and BBB- by Standard & Poor’s are considered below investment grade.
After losing 17 per cent in the previous 10 months, corporate debt has returned 8.9 per cent, including price gains and reinvested interest, since October 28 as the government committed $9.7 trillion to bailing out the financial system and agreed to back bank debt, Merrill data show. In the same period, the MSCI World Index of 1,685 companies in developed markets lost 12.5 per cent. The S&P 500 Index is down 13.8 per cent this year, the worst start in its 81-year history.
“Corporates have grown substantially, especially over the last couple of months,” James Tyree, chief executive officer of Mesirow Financial Inc. in Chicago, said in an interview.
“Increased liquidity helps everybody. It’s a far cry from when markets were frozen, although we’re certainly not back to what anybody would call normal.” Trading this year is up 8.5 per cent over 2008 and down 4.4 per cent from the same period of 2007.
The shrinking economy may curb trading, said James Barnes, a money manager at National Penn Investors Trust Company in Reading, Pennsylvania.
“The markets are completely driven by the US government’s involvement,” said Barnes, who helps oversee $500 million in fixed-income assets. “Volumes will go down as that pessimism starts to work its way back into the financial markets.”
The increase in trading may help bolster revenue at firms suffering from $1.1 trillion in credit losses and writedowns since early 2007, said Gary Townsend, a former bank analyst who is president of Hill-Townsend Capital LLC in Chevy Chase, Maryland.
Roche Bonds
Average daily trading of corporate debt by the so-called primary dealers that are obligated to bid at the Treasury’s auctions tripled since August to $19.8 billion, according to Federal Reserve data. New York-based Goldman Sachs Group Inc and Bank of America Corp in Charlotte, North Carolina, are among the 16 primary dealers.
Basel, Switzerland-based Roche Holding AG, the country’s biggest drugmaker by sales, offered $16 billion of bonds in the US this week to finance its acquisition of Genentech Inc in the second-largest corporate debt offering, according to data compiled by Bloomberg.
Trading plunged to the lowest since at least 2004 last year as investors fled all but the safest debt amid mounting losses on subprime mortgage-related investments and a deepening recession. As yields on corporate bonds rose, two-year Treasury yields fell to a record intraday low of 0.6 per cent on December 17.
Credit markets began to recover as the government started guaranteeing bonds sold by financial institutions, the Fed purchased commercial paper and the Obama administration introduced its fiscal stimulus package, said National Penn’s Barnes. The government has invested more than $250 billion in US banks, insurers and credit-card companies.
TED Spread
The difference between what banks charge each other for three-month loans and what it costs the Treasury to borrow for the same period fell last month to less than 1 per centage point for the first time since August. The so-called TED spread is down from 4.64 percentage points after Lehman Brothers Holdings Inc filed for bankruptcy protection in September.
Losses at the biggest banks and securities firms are leading smaller firms to expand.
Mizuho Securities USA Inc in New York, one of the primary dealers, tripled its bond staff in the past year to about 35, said Timothy Cox, an executive director in debt capital markets. The firm’s corporate trading increased 50 per cent to 60 per cent over the past year, he said.
Southwest Securities’ taxable fixed-income business was up almost 300 percent in the quarter ended December 31, said Leland, who plans to add 20 people to the firm’s 31-person corporate bond sales staff over the next two years.
“It’s been a good environment to be in the corporate bond cash trading space,” said Tim Cronin, head of the fixed-income group at Jefferies Group Inc in New York. “Demand for corporates in general is very strong.”
Per-Trade Profit
The rally and increased trading have narrowed profit margins. The so-called bid-ask spread on about 1,780 investment- grade bonds sold over the past decade averages about 19 basis points, excluding securities with spreads of 100 basis points or more, according to composite pricing data compiled by Bloomberg. That amounts to about $14 in commission per $1,000 bond, compared with about 32 basis points and $24 in commissions in late September. A basis point is 0.01 percentage point.
Bonds are still more profitable than seven years ago when regulators created the Trace bond-pricing service, giving anyone with an Internet connection access to trading details.
The bid-ask spread was about 7 basis points, or $5, for investment-grade bonds before Trace and about 4 basis points, or $3, immediately after, according to a study by Kumar Venkataraman, an associate finance professor at Southern Methodist University’s Cox School of Business in Dallas, published in the Journal of Financial Economics.
“Whenever there are wider bid-ask spreads, transactions are generally more profitable,” Leland said. “Southwest Securities is gaining market share in the corporate arena and I believe there’s other regional dealers doing the same.”
