US corporate bond
inventory at US broker dealers is now at nine-year lows as the
Volcker Rule and
Basle III requirements loom.
Inventories of US
corporate bonds with 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
– according to the Federal Reserve Bank of New
York’s monthly dealer updates.
|Inventory drops off a
of corporate securities with more than one year to
maturity held by US dealers
Reserve Bank of New York
The low levels of inventory are not expected to tick up. Brad
Rogoff, head of credit strategy research at Barclays Capital in
New York, says: "There was a question of whether the downward
trend in inventory was cyclical or secular, but now we know it
is the latter. 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. Basle
III’s requirement for increased risk-weighting of
debt is also discouraging dealers from holding certain
The lower inventory, and
therefore less liquidity, in the US corporate bond market has
ramifications for issuers, and the impact is evidenced in
According to 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.
Rogoff says: "The coupons that smaller, less-liquid companies
are being forced to pay are increasing. Even if the triple-C
bonds are participating in a market rally, their coupons in
primary market deals have to be higher than before."
Brad Rogoff, Barclays Capital
At some point, the higher
coupons might prevent some issuers from accessing the market,
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 liquidity in their bond funds, and, with less
liquidity in the system, they are having to pay more for liquid
holdings and rethink their investments in smaller, less-liquid
In the Investment Company
Institute’s (ICI) 41-page letter to the SEC, it
states that less liquidity has serious implications for
registered funds. "It leads to wider bid-ask spreads, increased
market fragmentation and ultimately higher costs for fund
shareholders," it states.
The letter also points
out that the Volcker Rule as it stands will limit the
investment opportunities for funds as the "narrow exemption in
the proposed rule for trading outside of the United States
could significantly limit US registered funds’
access to non-US counterparties".
The window for opinion
letters from market participants regarding the proposed rule
closed last month. The SEC received almost 15,000 public
comments, and regulators have until July to complete the
Barry Zubrow, chief risk
officer at JPMorgan, wrote in a 67-page letter that the
proposed rule would have "serious, adverse effects on our
ability to manage our risks and address the needs of our
clients, and on market liquidity and economic growth".
Paul Volcker submitted a
five-page letter to the SEC defending his own rule. "My short
answer to each of these objections is: Not so’,"
he wrote. Proprietary trading, Volcker said, is "at odds with
the basic objectives of financial reforms: to reduce excessive
risk, to reinforce prudential supervision and to assure the
continuity of essential services".
Dealers say there is hope
the language in the Volcker Rule will be changed to stop
inventory falling further. It is unclear, for example, what
constitutes proprietary trading and what does not. If a dealer
holds a bond for a year to make money, then that would be
deemed to be proprietary trading, but holding a bond for a week
to meet client demand is allowed by the rule.
saying that dealers have to accurately predict client demand to
own bonds," says the head of one US broker dealer. "If dealers
could do that, they would be making money every day. That does
not make sense and the wording has to change to allow greater