Bloomberg News

Trace Illuminating 144As Portends Broker Squeeze: Credit Markets

September 25, 2013

Corporate-bond brokers may face a squeeze on profits as regulators start publishing prices for almost $1 trillion of privately sold debt, if the past is any guide.

The Financial Industry Regulatory Authority, seeking to “foster more competitive pricing,” plans to start disseminating trading levels for securities issued under a rule known as 144a on its 11-year-old Trace system within the next year. That means the notes, sold only to institutional investors, will face the same price transparency as publicly registered corporate bonds for which buyers demand half a percentage point less in yield spreads. Brokers typically are paid larger fees from higher-yielding debt.

Firms from Knight Capital Group Inc. to Gleacher & Co. and Pierpont Securities LLC sold or shuttered credit units this year as corporate-bond trading volumes fell to the lowest proportion of the market on record and smaller price swings shrink potential profit margins. In the 90 days after Trace started disseminating prices of junk bonds, trading in the securities dropped 41 percent, according to Massachusetts Institute of Technology and Harvard University researchers.

Market Insecurity

“You get a certain amount of insecurity because of how opaque this market has been,” Ari Gabinet, OppenheimerFunds Inc.’s general counsel in New York, said in a telephone interview. “Without active market information, you don’t have a good way of assessing your execution.”

Sprint Corp. and Tenet Healthcare Corp. are among companies that have issued bonds under the 144a rule this year, according to data compiled by Bloomberg. The securities have grown to account for 33 percent of dollar-denominated junk-bond trading, the greatest percentage on record and up from about 25 percent a year ago, Barclays Plc data show.

There are as much as $300 billion of speculative-grade notes in the U.S. filed under the rule, and about $670 billion of dollar-denominated investment-grade corporate bonds, according to Barclays.

Investors are demanding an average of 54 basis points, or 0.54 percentage point, more yield to own speculative-grade 144a bonds, which require less financial disclosure than publicly registered securities, Barclays data show.

Cost Savings

By selling bonds under Securities Act Rule 144a, corporate borrowers can avoid filing financial disclosures as long as they sell the notes only to qualified institutional buyers, saving them money otherwise spent on regulatory compliance. That often leads to higher yields to compensate investors for the reduced transparency and liquidity that can make it tougher to sell the bonds.

The change will “enhance pre-trade price discovery, foster more competitive pricing, reduce costs to investors and assist market participants in determining the quality of their executions,” Finra said in a July 17 filing with the U.S. Securities and Exchange Commission, asking for approval to expand Trace to include price dissemination on 144a bonds.

“The Trace expansion is coming at a time when dealers already are dealing with increased legal, compliance and other costs, including tightening capital regulation,” said Russell Sacks, a partner at law firm Shearman & Sterling LLP. “You can see how small dealers especially, but dealers of any kind, would see themselves as being under pressure from both sides.”

Credit Benchmarks

Elsewhere in credit markets, Wal-Mart Stores Inc. (WMT:US) plans to sell bonds in a two-part offering that includes its second 30-year securities this year. China National Offshore Oil Corp., parent of the nation’s biggest offshore energy explorer Cnooc Ltd., signed $3 billion of syndicated loans with 11 banks.

The cost to protect against losses on U.S. corporate debt was little changed. The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, declined 0.3 basis point to a mid-price of 78.7 basis points as of 11:55 a.m. in New York, according to prices compiled by Bloomberg.

In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings increased 0.2 to 97.7.

Verizon Bonds

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 2 basis points to 13.25 basis points, reaching the lowest intraday level since Sept. 16. The gauge typically narrows when investors favor assets such as corporate bonds and widens when they seek the perceived safety of government securities.

Bonds of Verizon Communications Inc. (VZ:US) are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 7.7 percent of the volume of dealer trades of $1 million or more, Trace data show. The New York-based telephone carrier raised $49 billion on Sept. 11 in the largest corporate bond issue ever.

Wal-Mart, the world’s largest retailer, intends to issue (WMT:US) senior unsecured debt due in December 2018 and October 2043, according to a person with knowledge of the sale, who asked not to be identified because terms aren’t set. Wal-Mart has $44.2 billion of bonds outstanding (WMT:US), according to data compiled by Bloomberg.

China Offshore

The offering will be of benchmark size, typically at least $500 million, the person said. Wal-Mart is rated Aa2 by Moody’s Investors Service and an equivalent AA at Standard & Poor’s and Fitch Ratings.

China National Offshore Oil obtained $2 billion in a one-year term facility and $1 billion in a five-year term portion, according to three people familiar with the matter, who asked not to be identified because the details are private. The deal was signed on Sept. 17, they said.

The company completed the loan as the oil and gas producer seeks to raise even more debt. The company is considering selling U.S. dollar-denominated bonds and has hired banks to arrange meetings with investors in Europe and the U.S., a person familiar with the matter said last week.

The lenders are Australia & New Zealand Banking Group Ltd., Bank of America Corp., Bank of China Ltd., Barclays, China Construction Bank Corp., Citigroup Inc., Commonwealth Bank of Australia, Goldman Sachs Group Inc. (GS:US), HSBC Holdings Plc, Mizuho Bank Ltd. and Sumitomo Mitsui Banking Corp., the people said.

Dissenting Opinion

Finra’s plan to publish trade information for 144a bonds, the first expansion of Trace’s corporate-debt offerings since 2006, drew a dissenting opinion from the Securities Industry and Financial Markets Association. Disseminating the privately sold debt’s pricing “is not appropriate or necessary at this time,” Sifma’s Chris Killian wrote in a Nov. 16 comment letter, citing “concerns around changes in market liquidity and the impact of many regulatory changes.”

The SEC approved Finra’s plan to publicly report trades of 144a corporate bonds this month. Finra has until Nov. 6 to release a schedule for its implementation, which then must take effect within 270 days of the publication of that regulatory notice.

Trace reporting, which was introduced in 2002, has contributed to a reduction in trading of corporate bonds while cutting price volatility in the market, researchers at MIT and Harvard said earlier this month in a study of Finra data. Junk-bond trading fell 41.3 percent and price dispersion shrank 24.7 percent in the 90 days after the final phase of Trace’s implementation started, according to the study.

Trading Volumes

“As with all fixed income, you’re talking about an asset class that’s thinly traded,” said Mark Hepsworth, president of pricing and reference data for Interactive Data Corp. “The more market color can be shared the better. We think it can be a contributing factor in increasing trading liquidity.”

Trading volumes have dropped to 0.3 percent of the $5.4 trillion corporate-bond market in the U.S., about the lowest proportion ever, as transactions fail to keep pace with unprecedented issuance. After reaching a record-low 3.35 percent on May 2, yields on securities issued by the riskiest to the most-creditworthy borrowers are holding more than a percentage point below the average of 5.18 percent since 2008, Bank of America Merrill Lynch index data show.

The extra yield investors demand to own the debt instead of similar-maturity Treasuries has plunged 586 basis points during the same period to 218 basis points, reducing the potential margin for broker profits.

Pierpont, Gleacher

The difference between prices at which brokers will buy and sell bonds typically widens as yields increase and tighten as they decline. The MarketAxess High-Grade Bid-Ask Spread Index, which gauges liquidity in U.S. corporate bonds, plunged to 8.18 on Sept. 23 from 42.6 on Nov. 3, 2008. In that period, yields on the debt dropped to 4.09 percent from 10.96 percent, according to the Bank of America Merrill Lynch U.S. Corporate & High Yield Index.

Stamford, Connecticut-based Pierpont, one of the dealers started after the 2008 collapse of Lehman Brothers Holdings Inc. decided to exit the high-yield bond and loan business this month. New York-based Gleacher said in April that it was exiting fixed-income trading and sales. Knight in Jersey City, New Jersey, sold its credit-brokerage unit to Stifel Financial Corp., according to a July 1 statement.

Capital Rules

Jefferies Group LLC, the investment bank owned by Leucadia National Corp., said profit plunged 83 percent in the three months ended Aug. 31 as trading revenue fell to the lowest since the depths of the financial crisis.

“We’re in a more regulated world,” said Eric Gross, a credit strategist at Barclays in New York.

As the 27-country Basel Committee for Banking Supervision increased capital withholding standards for banks, the 21 primary dealers authorized to trade with Federal Reserve have cut corporate-debt holdings 11 percent, to $16.6 billion on Sept. 11, from $18.7 billion on April 3. That follows a 76 percent reduction in inventories from the peak in 2007 through March, when the Fed changed the way it reported the data.

“It’s a balance between consolidation in the brokerage industry and inefficient business models,” OppenheimerFund’s Gabinet said. “When the balance gets out of whack in either direction, those markets get squeezed.”

To contact the reporter on this story: Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net


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Companies Mentioned

  • WMT
    (Wal-Mart Stores Inc)
    • $76.82 USD
    • -0.24
    • -0.31%
  • VZ
    (Verizon Communications Inc)
    • $50.32 USD
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