Blockbuster CVS Sale Masks Turmoil in Corporate Bond Market
(Bloomberg) -- Wall Street’s bankers have made a fortune from funneling trillions of dollars of Corporate America’s bonds into investors’ portfolios, a party that continued this week with CVS Health Corp.’s $40 billion debt sale.
But there are signs that the band may soon stop playing, and the punch bowls may be disappearing. U.S. investment-grade corporate bonds are one of the worst-performing of the major asset classes so far this year, hurt by rising rates and investor fears that trade wars will hamper company profits. Bond offerings are slowing, and banks are earning some of the lowest fees on record, in percentage terms, to underwrite the debt.
“The road ahead for the corporate market may be bumpier,” said Gene Tannuzzo, a portfolio manager at Columbia Threadneedle Investments, which manages $494 billion in assets.
Investment-grade bonds have returned negative 2.7 percent so far this year, the worst start for the asset class in decades, Bloomberg Barclays index data show. Rising interest rates -- and the fear of more rate hikes to come -- are mostly to blame, with the yield on the 10-year U.S. Treasury note jumping almost half a percentage point since the end of 2017. Given its small coupons, the high-grade market is extremely sensitive to rate movements.
Slower issuance, weaker returns, and lower underwriting fees are all a reversal of the past decade of easy money. For five straight years, companies have sold record amounts of U.S. investment-grade debt. Corporations borrowed to buy rivals, pay dividends, and buy back shares, and investors were willing to tie up their money for decades to fund it all.
The debt binge was profitable for Wall Street, which earned an estimated $7 billion of fees from underwriting U.S. investment-grade bonds last year and $6.9 billion the year before, according to data compiled by Bloomberg. While the fees in percentage terms dropped to near all-time lows, the ballooning volume of issuance made up for any missed banking profits.
Unfortunately only one part of that trend is continuing: underwriting fees have continued to drop this year. But companies aren’t selling nearly as much debt, with investment-grade bond sales on pace for the slowest start to a year since 2015. Even including the behemoth CVS deal, the $287.2 billion of the notes sold so far in 2018 through Thursday compare with $335.3 billion in the same period last year, Bloomberg data show. Morgan Stanley forecasts that issuance would drop 3 percent this year compared with last.
“Companies that have utilized the debt markets as their own piggy bank aren’t necessarily doing so anymore unless they need to,” said Jody Lurie, a corporate credit analyst at Janney Montgomery Scott LLC.
Investors are growing warier of buying into new deals as some recent ones underperform. For example, prices on $1.75 billion of bonds from a Marathon Petroleum Corp. master limited partnership, MPLX LP, have fallen by more than 2 cents on the dollar since the securities were issued last month. Prices on $2.5 billion of bonds from Chinese social media company Tencent Holdings Ltd. have fallen by more than 3 cents since being sold in January.
The CVS sale on the surface went well. Aimed at financing the drugstore chain’s $67.5 billion takeover of health insurer Aetna Inc., the offering drew three times as many orders as bonds available to sell. The debt rallied immediately after the close of Tuesday’s sale, rewarding investors with nearly $450 million come Wednesday if they were able to grab of piece of the action.
“This was as efficient as you’re going to get to raise $40 billion in the context of a market where volatility is up and transparency for a large size deal is down,” said Justin D’Ercole, co-head of global syndicate at Barclays Plc, the lead manager on the sale.
Still, the company had to offer discounts on seven of the nine portions to entice buyers. The day after the sale was completed, CVS was paying an average coupon of 4.12 percent on all its debt compared with 3.95 percent a year earlier, Bloomberg data show. That’s not a huge increase in borrowing costs, but it reflects a broader weakening in the market that makes it less attractive for companies to sell debt.
“All of that is playing into whether this current easy credit market is going to continue or whether there will be a shift,” Janney Montgomery Scott’s Lurie said.
And even though the new CVS bonds rallied on Wednesday, the rest of the $6 trillion market on average did not. Yields on the debt ticked up to 3.76 percent, the highest since 2011.
“Performance in the investment grade bond market, like other asset classes, has had a challenging start to the year,” said Dan Mead, head of the U.S. investment grade syndicate desk at Bank of America Merrill Lynch, which helped underwrite the CVS deal. Other banks on the deal declined to comment. “However, as we have also seen, there is significant liquidity available for borrowers in the investment grade bond market.”
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