Can you hear me now?
Yesterday Verizon priced $51 billion worth of bonds at $49 billion. Technically they sold $49 billion of bonds at $49 billion that then traded to be worth $51 billion. That is a lot of profit to those who got good allocations.
That is positive for the market. Some “free money” goes a long way towards building confidence. It has been a choppy couple of months. Long only funds have struggled to show good returns. This should help their performance. Hedge funds will benefit from this as well. All in all, this shows how much “cash on the sidelines” there is. This deal had a very large concession, but got done easily and traded well.
This deal provided a great opportunity for active managers to outperform passive funds.
It also seemed to help the Treasury market. Allegedly Verizon had a very large rate lock and unwinding that helped Treasuries. It looks like Verizon should have spent less time worrying about rates and more time worrying about how cheap their deal was getting priced at.
The size of the deal also gave confidence to Treasury traders that there is a deep bid for bonds “at a price.” That the sell-off isn’t a panic trade; it is just a reflection on Fed policy and economic conditions
The strong 10-year Treasury auction also helped (though I suspect it isn’t a co-incidence that the Verizon deal priced on the same day as the 10-year, especially if the Verizon bonds had a large rate lock).
Investors Weren’t Selling Other Bonds to buy Verizon.
It is hard to tell, but there was no noticeable increase in TRACE volumes ahead of the Verizon deal. If investors had needed to sell other bonds to buy Verizon we should have seen an uptick in volumes. There was nothing to indicate that the bulk of the deal was purchased on swap (selling other bonds to buy this). That is encouraging.
A Spread Disconnect
Having said all these positive things about the deal and what it did for the market we are left with a disconnect in spreads. Verizon looks cheap. Verizon spreads blew out on the back of this deal and remain elevated.
Some part of that increased spread is simply that you have a much more leveraged company. That spread increase should remain, but even with that, it seems to me that this deal is pricing cheaply.
Spreads will tend to converge. So one of two things will happen over the next week or so.
1. Verizon bonds will grind tighter and “normalize” so that they don’t seem particularly cheap
2. Verizon bonds will struggle here, more new issuance will come, and secondary market prices for other bonds will look expensive and you will see selling pressure there.
Today, at this moment in time, Option 1 seems the most likely, but realistically it is probably 50/50 in terms of Option 2 playing out. Cash positions, by definition, have to have been reduced to purchase Verizon, and other companies will be tempted to tap the market. Every capital markets person is on the phone with their best bond issuers whispering sweet nothings about the great execution they can get based on strong demand for paper in the market.
Remember RJR Nabisco?
It isn’t unheard of for a big bond deal to mark a temporary peak in the market.
Economic data has been okay, but is possibly slowing, and companies are leveraging up. That is not good from a creditor perspective. Growth is still good enough that it isn’t a major concern, but the trend isn’t particularly creditor friendly.
The Return of the Floater
The floating rate bonds are interesting. The five year came at LIBOR 175. They traded up not because of interest rates but solely because the 5-year spread was too cheap. It has been a long time since we saw a floater trade up like that. It is interesting and could help some of the floating rate funds attract more money as they can start sourcing some bonds where they benefit from credit spread tightening and not just the hope that the Fed will hike rates.