By Joseph Neu
Acquisition financings can say a lot about the state of capital markets at key inflection points. Amid all the taper talk (which had Fed tapering set to begin this month) and the bond market’s reaction to it, the market appears to be at one at with itself.
This is why Verizon’s extra large $49bn debt issue to help fund the $130bn purchase of Vodafone’s stake in Verizon Wireless is so important. It will help answer the question: Did Apple call the top of the historic corporate funding opportunity, or are we fools to think the debt party was coming to an end?
Now that the largest corporate bond issue ever was easily sold, amid taper talk and threats of war with Syria, we should question if the bond market can really be all that bad. And what does the ability of the underwriting banks (JP Morgan, Morgan Stanley, Bank of America and Barclays) to syndicate a $61bn bridge loan in this same environment say about investment-grade bank financing?
Party On
The party is still on—most likely: It’s just “happening” a bit more over in the VIP area, where the liquor costs more. Here are some further reasons why Verizon will put at least some funding and bond market fears to rest.
- The rating agencies were quick to downgrade. Both S&P and Moody’s lowered Verizon’s rating one notch (BBB+ from A- and Baa1 from A3). S&P expects the firm’s funding from operations to debt ratio to fall into the low 20 percent range. Moody’s, similarly says that “leverage will be materially higher than our prior forecast;” plus, it sees dividend commitments and higher tax payments offsetting the debt paydown prospects of additional cash flows gained from sole ownership of Verizon Wireless.
Even if rating agencies’ opinions still matter, in a world without a risk-free rate, BBB is the new AAA.
- The great unwind will be too painful. The August issue of Risk had “The great unwind” as its cover story. It highlighted how buy-side firms are fretting about selling off their major accumulation of bonds in a market where dealers, hemmed in by bank regs, are less able to provide liquidity to enable orderly sales. This summer was merely the trailer for the horror movie to come.
It is easy to look at the decline in dealers’ corporate bond inventories with concern: primary dealers have seen their corporate bond inventories fall from a high of $235bn in October 2007 to $55.9bn at the end of last March.
However, it is just as likely that the bond market will figure out how to function with dealer banks holding less than 1 percent of outstanding corporate debt. Plus, Risk seems to conclude that firms like Verizon will not feel the impact. Dealers will allocate their balance sheets to their best customers.
Also, since a great unwind will prove painful for so many, odds are, market participants will find any way to prevent it.
- Too many vested in Verizon issue’s success. Seen more broadly, there are simply too many market participants vested in the success of Verizon’s financing to let it be otherwise. It is not just the lead Verizon banks that want this deal to succeed, the global financial economy needs positive deal flow to keep it from stalling.
As evidence, while the taper may not be called off, there is increasing talk of tapering it. Also, looking down the road to when the Fed needs to sell its bond inventory, it does not want investors to have just sat through a long horror movie. [Note: Dealer inventories of Agency and Government debt have declined even further than holdings of corporate debt.] The Fed should rather have the Verizon issue be seen as the end of irrational fixed income fear. Along with the Fed and the dealer banks, many corporate treasurers looking to issue new debt have to have been rooting for Verizon too.
are you a VIP?
But here’s the rub, if you don’t have the “wallet” of a Verizon, you may well find market windows closed. You’ll certainly have fewer funding tranches to tap after Verizon fires all its torpedoes. Banks will try to use the blockbuster deal’s pricing benchmarks to set financing costs higher. And this will underscore the risk for non-VIP issuers, even after they’ve made every concession. However, inside the velvet rope, as Verizon will show, the party continues.