Market proved willing to absorb the offering; 'not a lot of investment-grade stuff' right now
If Wednesday’s record-setting $49 billion bond sale by Verizon Communications signaled anything about the financial markets it is that investors are still starving for yield.
The investment-grade debt issuance, which was nearly three times larger than Apple Inc.’s $17 billion bond sale in April, has been described as well-timed and well-priced.
“There is not a lot of investment-grade stuff on the market right now, and there is definitely a thirst for it,” said Michael Cavanaugh, principal at RCM Wealth Advisors.
Although some market watchers initially flinched at the overall size of Verizon’s bond offering, even with yields of 6.5% on the longer-dated bonds, the market proved ready and willing to absorb the bonds.
The demand was so strong that in the secondary market the 30-year bond yields were pushed down by 50 basis points to about 6% in the first day of trading.
“People who have been savers and are conservative have been looking for decent yields on debt, and they perceive this Verizon debt to be safe so folks are jumping in,” said J. Brent Burns, president of Asset Dedication LLC.
“Consumer savers have really been taking the brunt of the low-rate environment, and from a financial planning perspective the low interest rates mean people don’t have as much money to spend or live on,” he said. “Basically, investors were really happy with 6.5%, but they’re still happy with 6%.”
For perspective, the 6%yield in the secondary market compares with a 3.85% yield on the 30-year U.S. Treasury bond, and the average coupon on Apple’s entire $17 billion bond sale was just 1.8%.
From a pure safety and security perspective, Verizon debt doesn’t stack up evenly with debt backed by the U.S. government, but it is still categorized as investment-grade corporate debt.
Based on market demand, some analysts estimated that Verizon could have nearly doubled the issuance and still had a successful bond sale. The debt issuance, which will be used to help finance a $130 billion acquisition of Vodafone’s share of Verizon Wireless, was originally set at less than $30 billion.
The increased balance sheet leverage from the debt sale did push Verizon’s debt rating down to a high triple-B rating from a low single-A rating, but it wasn’t enough to move the company below investment-grade.
“The success of the sale suggests there is a lot of demand for high-quality corporate bonds, and it probably surprised some people in the bond market,” said Michael Collins, senior investment officer at Prudential Fixed Income.
“Maybe this means that yields have increased enough to start bringing buyers back in,” he said. “This was so easy for Verizon to get done, you can imagine other treasurers and chief executives and chief financial officers that were considering acquisitions that might now be emboldened by this deal.”
Based on the way the market drove down the Verizon yields in the secondary market, Mr. Collins doesn’t think that bond yields are poised to spike from here, as some analysts have speculated.
“I’m seeing buyers coming in dying to buy this thing because it’s so attractive, because anyone who has gotten out of bonds and gone to cash is saying they can’t afford to earn zero anymore,” he said. “This may be the highest yield we see on 30-year investment-grade corporates for a long time.”
Meanwhile, with the Federal Reserve expected to start trimming its five-year Treasury-bond buying program this month, not everyone concurs that bond yields have hit a near-term ceiling.
“I think people see those kinds of yields that are a lot better than what they’re currently getting, and they aren’t considering the amount of risk they’re taking on right now,” Mr. Cavanaugh said. “When interest rates start to go up the current bond yields become less attractive.”
Along those same lines, Dan Heckman, senior fixed-income strategist at The Private Client Reserve of U.S. Bank, pointed out that the higher yields on some corporate debt could be exposing investors to new levels of duration risk just as rates are expected to start climbing.
“It is incredibly attractive for those who want that type of duration risk,” he said. “Maybe we have seen a near-term peak in rates in terms of the Treasury benchmarks, and there is still tremendous appetite from pension plans that need to meet their benchmarks and expected rates of return.”
