America’s New Bond Underwriters Have Arrived in Search of Alpha
June 24, 2015 — 7:48 PM CDTUpdated on June 25, 2015 — 8:23 AM CDT
The business of underwriting bonds is being turned on its head in the U.S.
Gone
are the days when money managers would passively wait for Wall Street
banks to pitch them deals. Now, they’re often the ones cooking up sale
plans with corporate issuers, haggling over maturities and interest
rates before taking them to the banks to finish off the transactions.
The goal: Carve out and keep a chunk of the new debt -- a precious
commodity in a market awash with cash after years of central banks’
easy-money policies -- before letting Wall Street distribute the rest.
It’s a transformation that’s been building since BlackRock Inc., the world’s biggest fund manager, brought in a
former Bear Stearns Cos. banker to start a capital markets group five
years ago, a hiring that helped mark investors’ intentions to drive more
of the process. Babson Capital and AllianceBernstein Holding LP, among
others, have since followed suit.
While
the Wall Street banks still collect the fees on the bond sales, the
shift underscores how they have ceded some of their influence in
financial markets to the world’s top asset managers in the aftermath of
the 2008 credit crisis.
‘Extremely Prevalent’
Precise
-- and even imprecise -- estimates on how much of the nearly $1
trillion of U.S. corporate debt sales this year was initiated by fund
managers are hard to come by, but traders, bankers and analysts all
agree that these deals account for a growing share of the market. One
recent example of a deal initiated by fund managers that produced quick
returns: Fortescue Metals Group Ltd.’s $2.3 billion sale in April.
These
transactions, known as reverse inquiries, “went from a weird, one-off
type thing until now,” said Peter Tchir, head of macro credit strategy
at Brean Capital LLC. “It’s become extremely prevalent and a tool that
everyone is trying to use. It lets you have a little more control over
what the issuance looks like.”
The
initiative sprung up because the sales have become more critical than
ever for fund managers. They provide access to bonds that can otherwise
be hard to obtain; and can juice returns when prices on the debt rally
right after the sale is completed -- a huge advantage in a market where a
paltry 3 percent yield has become the norm.
Banks Retrench
A
study carried out by Tchir, whose two-decade career in credit markets
has included stints at UBS AG and Royal Bank of Scotland Group Plc,
showed that a $168 billion pool of corporate debt sold in early 2014
added $1.5 billion of market value in the first 10 days after issuance.
The
underwriting business provides a window into the changing landscape in
the $39 trillion U.S. bond market. Much of the shift started with banks’
retrenching after new rules forced them to pare back risk in the wake
of the 2008 crisis.
They cut thousands
of jobs, leaving fewer veteran traders and bankers on bond desks, and,
in the process, became less active in day-to-day market transactions.
That often left their old clients, the money managers, to try to trade
directly among themselves.
The
push by fund managers into underwriting was a direct result in part of
this Wall Street scale-back: If it’s going to be this difficult to
locate and buy high-quality bonds in the secondary market, the thinking
goes, then get them right from the primary source -- when they’re
issued.
Over
time, “banks started to lose a connectivity to these money managers,”
said Michael Henderlong, who runs Babson’s capital markets group. “It
gets to the point where the dealers have a tough time accessing all the
different parts of the asset managers.”
AllianceBernstein Hire
Henderlong
joined Babson, the $217 billion investment management firm that’s part
of the MassMutual Financial Group, in 2013 after spending more than a
decade at Morgan Stanley and Goldman Sachs Group Inc., two of the top
ten underwriters in the U.S. corporate debt market. This month, Babson
added John-Michael Chadonic, who’d previously worked at Bank of America
Corp., to support the capital markets team by helping it understand who
owns what and who’s selling what on Wall Street - - a task the biggest
dealers once did.
At
AllianceBernstein, which oversees $500 billion of assets, money manager
Michael Sohr is responsible for holding constant talks with
corporate-bond issuers and banks about new debt sales in the works.
Getting in Early
Once
a sale is agreed upon with a company, a bank is found to distribute the
bonds that the money manager won’t keep. Sometimes the transactions are
private placements destined for only a handful of buyers; other times
they’re broadly distributed.
“We
want to get in there early and help structure it the way we want to,”
said Gershon Distenfeld, who’s director of AllianceBernstein’s
high-yield team. “Sourcing bonds had become increasingly important as it
relates to the primary market.”
It’s not that this phenomenon is brand new.
The
tradition of reverse inquiries -- money managers encouraging issuers to
to sell a certain type of bonds -- is decades old. It’s just that it’s
taking off now.
And
for the investment firms, there are more advantages than just obtaining
hard-to-find securities. They’re privy to more information than their
competitors and are able to dictate terms that are most beneficial to
them.
Like
that time in April when Franklin Resources Inc. and Capital Group Cos.
orchestrated Fortescue’s offering of junk bonds. Not only did their
involvement ensure that they received a hefty slice of the debt, which
carries an interest rate of just under 10 percent, it also allowed them
to secure a greater claim on the Australian miner’s assets, people with
knowledge of the matter said at the time.
The
bonds, meanwhile, have already generated a hefty profit. In the two
months since the sale, their price has soared 8.9 percent.
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