Credit Concerns Slow Corporate Bond Market
The investment-grade corporate bond market has ground to a halt, making it difficult for companies to access capital and hard for investors to find a place to put their money to work.
The problems in the high-grade market, which caters to companies with solid credit rankings, come amid turmoil in stock markets and high-yield bond and loan markets as investors, spooked by the troubles in the subprime mortgage market, turn their backs on risky assets. It amounts to a major reprising of risk after years of skimpy returns and low volatility.
"The market is just frozen up," said Jim Cusser, a portfolio manager at Waddell & Reed in Overland Park, Kan.
Activity has plummeted both in the secondary market, where existing bonds trade, and in the primary market, where companies sell new bonds to raise money for investment and working capital.
In a sign of the market's stress, some deals have even been pulled due to market conditions meaning the issuer and its underwriters didn't think the deal could be done on favorable terms.
The problems in the primary market could, if they persist, throw a serious wrench in the workings of corporate America, making it tougher for companies to finance, among other things, investments, buyouts and equity buybacks.
"It's a phenomenally tough time for liquidity," said Sid Bakst, managing director of Robeco Weiss Peck & Greer in New York, which has $9 billion in assets under management.
Last week, as the stock market reeled and investors fled to the safety of government bonds, just one issue was sold in the investment-grade market: a $2 billion 30-year fixed rate deal from General Electric Capital Corp., one of the safest corporate debt issuers, with an AAA rating.
BBB-rated Tyco Electronics , on the other hand, pulled its $1.5 billion three-part note July 26, citing "unfavorable conditions in the debt markets."
In July, corporate bond issuance in the U.S. was down 77% from June, according to data from Dealogic, a bond data provider. The number of high-grade deals sold in July fell sharply to 25, compared with 94 in June and 121 in May. A year ago, by contrast, 43 deals were sold in July.
Characterizing the market as having the "worst" liquidity "in many years," Bakst said "if you own an off-the-run name (a bond that doesn't trade often), liquidity is not good even on the days when the market is doing better."
Portfolio managers are having a tough time getting what seems like the most basic asset in credit markets: an investment-grade corporate bond.
Midday Thursday, Waddell & Reed's Cusser was in the market for a plain vanilla "high quality" corporate bond and was surprised to find that two dealers turned him down.
"This has not happened to me in 15 years," Cusser said. "They said they had nothing on offer."
As credit markets continue to tighten, market participants see increasing signs of what they call a "liquidity crunch" investors want to buy a bond but nobody's willing to sell.
Traditionally, when markets seize up as happened in the credit crunch of 2002 issuance comes to a halt and investors have trouble getting out of positions. What's different this time around is the ubiquitous presence of derivatives contracts derived from underlying assets which have allowed investors to continue to gain or cut back on their exposure to corporate debt of all types.
"A tremendous amount of money is in the derivatives products and that's how the game is being played," Cusser said.
These relatively young markets have sucked liquidity from the cash bond market because they are less cumbersome to trade and are the preferred venue for big market participants such as hedge funds.
Cusser, for one, said the dealers he had contacted encouraged him to buy credit default swaps, because high-grade bonds were not trading.
Beyond the spike in market volatility linked to the subprime mortgage market, where rising defaults and delinquencies are leading to the souring of investments made in the sector there's one more factor that can't be ignored entirely in the drying up of liquidity: The onset of summer, when many investors are on vacation.
"August is usually a slower month for issuance," said Cynthia Cole, senior portfolio manager at Allegiant Asset Management in Cleveland, Ohio, with $15.9 billion in assets under management. "With the volatility that's going on, this is not a great time to be issuing debt in any case."
Issuance is unlikely to pick up before fall when the fallout from the subprime mortgage market problems will be clearer and when, many hope, a certain measure of calm may return.