The massive $49 billion bond offering by Verizon Communications this week – far and away the largest of its kind ever seen – is serving as a great test of investor sentiment at a key turning point for monetary policy.
Verizon is issuing the debt in order to help pay for its $130 billion purchase of the 45 percent stake in its Verizon Wireless joint venture now owned by Vodafone Group PLC. The timing of the buyout may not have been dictated solely by expectations that the Federal Reserve will soon start pulling back its support for the bond market, but the impending policy change clearly meant the companies had a limited window to get the deal done.
If interest rates were to climb higher in response to the Fed’s policy change, Verizon’s required financing could become expensive enough to scuttle the deal. Back in the spring, when interest rates were languishing near their lowest levels in decades, Apple (NASDAQ: AAPL) issued what was then a record $17 billion in bonds. Since then, bond markets have soured and interest rates have surged. It’s not that debt financing has become pricey, merely that it is no longer nearly as cheap as it was only a few months ago.
Meanwhile, pundits have cautioned investors that further upticks in rates could leave them with losses. (Bond yields and bond prices move in opposite directions.) And the uncertainty that goes along with the looming Fed policy change could make fixed-income investors skittish about snapping up new issues, much less the kind of massive bond sale that Verizon needed.
Verizon and its underwriters – a consortium led by JPMorgan Chase, Morgan Stanley, Bank of America and Barclays – certainly felt a sense of urgency. They had planned to issue the bonds in a series of tranches over time, to minimize the impact on the market and ensure the deal could be completed as price-efficiently as possible. But underwriters are said to have received demand for as much as $100 billion in debt for what was expected to be a $49 billion issue, and that interest in the $14 billion of banks loans also was robust.
Clearly, Verizon has done the bond market and investment bankers a big service by timing its need for financing to coincide with this period of market uncertainty. That’s not just because the banks underwriting this massive debt issue will collect enough in fees -- $500 million or more, according to reports – to ensure this is a blockbuster year for fixed income bonuses, but because the transaction already is delivering a clear message about supply and demand trends in the bond market.
Bond investors have been yield-hungry and yield-starved for years. And while spreads have remained narrow (yields on investment grade debt had been trading at about 120 basis points, or 1.2 percentage points, above those on comparable Treasury securities), Verizon and its underwriters paid anywhere from 165 basis points (on the three-year fixed rate notes) to 265 basis points (on the 30-year bonds). That premium, while not making the deal prohibitively expensive for Verizon, clearly was enough to whip investors into a frenzy of excitement.
Now investors will be watching the bond market for any signs of buyers’ remorse, or weakening as the issue trades in the secondary market. Any indication that investors regret being caught up in a feeding frenzy, or were simply looking to “flip” the bonds to those who didn’t get the allocation they sought when the deal was distributed, might be seen as a sign of trouble in such a fragile and uncertain market environment.
Viewed in isolation, the Verizon debt issue looks like a win-win: The company gets the financing it needs on an affordable basis, while investors can finally lay hands on some investment-grade securities priced at more attractive levels than they have seen in years. It also may be viewed as a sign that the bond market, at this moment in time, is in Goldilocks territory: not too hot, not too cold, but just right. In other words, the backup in yields, however painful it has been for bond investors, has brought them to a point where new deals are seen as attractive and companies can still find it affordable.
Of course, no transaction takes place in isolation, and the market isn’t static. Is the Verizon deal the last big hurrah of an era of cheap debt – the end of the credit boom, as Forbes has opined? It certainly will reassure Fed policymakers that higher – or at least, slightly higher – interest rates won’t cut off corporate access to capital markets. If investors were truly, deeply anxious about the economic outlook, or expecting that interest rates would be significantly higher in six months’ time, they might well have been less eager than they were to try and snag as much of such a large transaction, even at a premium to current yields. They would have been more cautious, demanding higher yields or smaller issues, to gauge how well the market was digesting each transaction.
The window for such gargantuan transactions may well close in the coming days and weeks, as uncertainty increases. But then, the vast majority of bond market issues are much smaller. And unless the uncertainty causes a big spike in interest rates, rather than the kind of gradual upward drift that most economists currently expect, the success of the Verizon debt sale suggests that the hunger for higher yields and the ability of cash-rich corporations to offer small premiums may well offset the angst.