US corporate bond inventory at US broker dealers has slumped to a nine-year low, due to looming Volcker Rule and Basel III requirements.
According to the New York Federal Reserve monthly dealer updates, inventories of US corporate bondswith more than one year to maturity are just $45 billion – that compares with some $93 billion in February 2011, and $135 billion in February 2006.
The low levels of inventory are not expected to tick up.
“There was a question of whether the downward trend in inventory was cyclical or secular, but now we know it is the latter,” says Brad Rogoff, head of credit strategy research at Barclays Capital in New York. “After each of the sell-offs over the last two summers we have seen the inventory drop further. Even in market rallies there has been no bounce.”
The decrease in inventory is in large part due to the pending Volcker rule that prevents broker dealers from taking part in proprietary trading, therefore reducing the amount of bonds that a dealer can hold. Basel III’s requirement for increased risk-weighting of debt is also discouraging dealers from holding certain bonds.
The lower inventory, and therefore less liquidity, in the US corporate bond market has ramifications for issuers, and the impact is evidenced in issuance volumes.
According to data provider Dealogic, $138 billion had been issued in US investment-grade debt this year as of February 15 – almost $20 billion less than the same time-frame last year coming from 120 fewer issues.
As the Volcker rule approaches being finalized, concern about the impact on corporate borrowers is growing. Small- and medium-sized companies reliant on the bond markets to raise capital are facing higher premiums.
“The coupons that smaller, less-liquid companies are being forced to pay is increasing,” says Rogoff.
"Even if the triple-C bonds are participating in a market rally, their coupons in primary market deals have to be higher than before."
At some point, the higher coupons might prevent some issuers from accessing the market, he adds.
Even for larger corporates, there is a cost. Decreased liquidity is making their bond yield movements more volatile. The higher cost to US corporates of financing could mean that a US economic recovery will be slowed down.
An Oliver Wyman study commissioned by the Securities Industry and Financial Markets Association estimates that corporate issuers might incur $12 billion to $43 billion in incremental borrowing costs as a result of the rule.
Mutual fund managers are also critical of the rule in its current format. They are required to provide daily liquidityin their bond funds, and now, with less liquidity in the system, they are having to pay more for liquid holdings and rethink their investments in smaller, less-liquid bonds.
For the full story and how the Volcker rule could harm issuers and investors in the US corporate bond market, check out the March issue of Euromoney magazine
