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Mar 01

The T-Report: Bond IPO’s – A Peek into the New Issue Market

Bond IPO’s

I know they are technically New Issues rather than IPO’s but let’s just pretend for a bit. IPO sounds much more exciting.

I take a quick look at 3 equity IPO’s. I picked Facebook because I couldn’t resist given the hype versus actual performance, TWTR because it was big, recent, and did great, and TLMR because it was the largest deal that I could find this year.

Twitter is about as successful of an IPO as you could hope for. It was up 70%. It generated about $1.5 billion had people took the allocation and held on. And this was a BIG IPO, and had GREAT returns.

The Verizon long bond generated more in a week. Yes, Verizon was such a special case, that many “new issue concession” surveys have chosen to eliminate it because it skews the results so much. There were some other Verizon bonds issued at the same time. In total it was over $3 billion of “bond IPO” money that made its way into the bond market. It had the potential to make your year.

But TWTR and VZ are both extreme examples.

I am not a single stock equity person. It isn’t what I do, so I might be looking in the wrong place, but domestically I could only find fewer than 10 IPO’s this year. Of those, this TLMR was the biggest. Maybe I have my search criteria wrong, and I could be missing the importance of add-on deals, etc., but here is my extremely rough analysis

  • Big IPO’s are rare. Even decent sized IPO’s are not a regular occurance
  • Since only a portion of the total size is offered during the IPO, the amount that outsiders can get allocated is smaller still
  • Even with good percentage gains, the total amount awarded to those who receive allocations remains relatively low, with a few noticeable exceptions

But I don’t want to digress because this isn’t about equity IPO’s it is about bond IPO’s.

How Much Wealth do Syndicate Desks Control?

I will limit myself to domestic bonds that are issued by corporations. I will include investment grade and high yield. I am not including convertible bonds, leveraged loans, I am not including structured notes, asset backed bonds, etc., just simple bonds issued by corporations and financial institutions. I will even limit it to deals that are at least $250 million.

Here is what I get:

I wound up getting 243 bonds totaling $168 billion.

I got the 1 day P&L to be $811 million, the 5 day to be $1.2 billion and the 10 day to be $1.5 billion.

Here are the caveats to that data:

  • I used price rather than spread for investment grade bonds, and since hedge funds at least would run IG on a spread basis that creates an error
  • Some bonds have an announce date, but no trading, so I can be off by a day here or there
  • I had to use pricing from Bloomberg/TRACE which is of marginal accuracy and surely introduces some errors, though I don’t think it would have a big bias up or down as a whole
  • 25% of the sample didn’t have any pricing that I could find easily, so I assumed they had the average returns of the other 75%.
  • Recent new issues don’t have 5 days or 10 days of pricing so I assumed the last day of pricing for those dates

So, the quality of the data is not as good as I would like, but the numbers make sense and seem in line.

The average 1 day gain was 0.5% and it was almost 0.91% by 10 days.

Looking 5 days out, only 13% of the deals had losses. So 87% of new issue purchases were winners – a very high “win rate”.

The only significant “losers” were bonds issued around January 22nd when the S&P started to slide. The total amount of losers on the bonds I had pricing for was $36 million, of which $15 million was an Icahn bond priced on the 22nd and a JPM bonds priced on the 21st.

Investment grade deals represented about 73% of the total number of issues and 77% of the total volume but only 55% of the new issue discount.

While the average 5 day profit was 0.7% the mix was 0.5% for IG and 1.36% for high yield (which again, seems about right).

How hard is it to make 1.36%?

Maybe it is easy to make 1.36% in 5 days in the high yield space?

On HYG as a proxy, had you bought at the bottom on February 3rd, you could have made 2.6%. Better than 1.36% but you need to time it perfectly.

The year to date return is 2.7% but almost 1% of that will be dividends.

So from what I can tell, in this market, getting 1.36% in 5 days is pretty good and hard to compete with.

High yield new issues had a 90% win rate.

Regency and Blueline both “earned” their lucky buyers more than 3.5% in 5 days.

So I would argue that it is relatively hard to do better than the new issue market where the returns are good relative to the overall market and the win rate is very high.

Is it Fair?

That is a big question, and I don’t have the answer. There are some reasons to justify the existing methodology, but there are some problems that come from it.

The reasons it makes sense

  • In spite of how easy it seems, there is often angst around the pricing of each issue, and without the potential to generate excess returns why would you look at financing new bonds or new companies. So the excess returns are a reward for the work, effort, and in theory risk of the new issue
  • We are looking at only a short time period, where the underwriters are likely to support the new issue, there is risk, particularly with smaller, lesser known issuers, that the liquidity could drop so you are being paid for that
  • While wanting the process to be competitive, there are certain customers who are there all the time, supporting each and every new issue, so a process to reward them needs to be in place, because the new issue franchise could be hurt (selfish) but it could also hurt the ability of issuers to get good pricing (altruistic).
  • There is a skill to creating an allocation that causes such good performance. In the hands of an auction or first come first served, then the results might not be so pretty which hurts the entire market in the long run.

The concerns

  • In an era where transparency and “fair play” are the watchword, this seems one of the last places where the P&L potential is major and the rules and guidelines leave a lot of latitude. Some might be concerned that latitude is misused.
  • It is a major reason boutiques can struggle and electronic trading has been miserable. It rely ties execution to a few banks. If XYZ bank had an IPO every day to offer, they could in theory get great flows to help sway their allocation decision. Well, in fixed income, some banks do have a deal a day.

This was motivated by an article I saw in the FT on Friday.

I think the “risk/reward” is heavily skewed in your favor to play new issues (but we all know that) and while the existing system may have flaws, it has some advantages (unfortunately in my current seat, few of those advantages flow to me).

With the path regulators are heading in general, it seems like a possibility that they will push the system to something more open (whether that is the right decision or not) which could benefit some players and hurt others (the big new issuers). It is also likely to have unintended consequences, some potentially negative for the issuing corporations, because the system is complex and the parts are interconnected and pushing for changes in one place, rarely has the isolated, simple, desired effect hoped for.

 

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