Investors seem happy and flocked together like they were going to a feast. The Verizon (VZ) bond deal was a steal. Investors in Wednesday's offering of Verizon Communications bonds took home a 5.2 percent yield for the 10-year bond and 6.55 percent for the 30-year bond.
These yields are far better than U.S. Treasury bond yields where the 10-year bond closed to yield 2.91 percent yesterday and the 30-year bond closed to yield 3.85 percent. It is also better than investors could get on the average of BBB-rated industrial bonds that are averaging in around 4.15 percent and the BBB-rated telecommunications bonds averaging around 4.35 percent.
The yields had to be high relative to the market. This was the largest deal of its kind in history…$49 billion…exceeding the recent Apple deal of $17 billion.
But, the interest rates had to be high because there is a strong possibility that longer-term bond yields are going to be heading higher in the near future. Some inducement had to be included in the offering.
There is a good bet that this latter point is exactly what the Verizon management was thinking about. Verizon, of course, had to finance the Vodafone acquisition. It had initially financed the deal with bank loans. This bond issue will allow Verizon to pay them off very quickly.
But, Verizon had other financing plans in place if they were needed. According to David Gelles in the New York Times: "The company initially signaled that it might sell $20 billion in dollar-denominated bonds and make further bond sales in euros and British pounds. But as orders came in on Tuesday, it was clear that demand would permit Verizon to issue all its bonds in dollar denomination. By Wednesday, more than $100 billion of orders had come in, and the company was able to complete the offering that afternoon."
Furthermore, it is long-term...very long term!
Verizon may have pulled off the deal of the decade.
After a 30-year bull market in bonds, there is talk now of a bear market in bonds. It is just possible that the movement up in interest rates over the past three months is just the beginning of what may be a secular trend to higher long-term interest rates.
And, the Federal Reserve may have very little power to stop the rise over time.
Many analysts have argued that the recent rise in rates has occurred because Mr. Bernanke and the Fed have talked about the Federal Reserve beginning a process of tapering the Fed's purchase of securities every month. The talk about tapering may have had some impact in the market's move to higher longer-term interest rates but, as readers of this blog know, my belief is that a lot of the movement in the yields on U.S. Treasury securities has come because of money that originally came from Europe seeking a safe haven is now just returning to Europe.
The Federal Reserve, I believe, can do very little to halt this flow of funds and, hence, can do very little to stop the rise in long-term U.S. interest rates.
Then, as my post on the possibility of a bear market in bonds argues, the impact of five years of Federal Reserve quantitative easing may finally start to cause some increases to take place in actual inflation, leading to a rise in the inflationary expectations built into market interest rates. If this happens, then longer-term interest rates will rise even further…and the Fed will be able to do very little about the increases.
Verizon's success may bring on copycats. As Gelles writes in the Times, "The ease with which Verizon raised so much money caught even longtime market participants by surprise and fed speculation that more companies might tap the debt markets before interest rates begin to rise, as expected."
But, more issues being placed into a market that expects interest rates to rise will have the impact of causing these interest rates to rise even faster.
Plus there is the problem that I wrote about yesterday, the problem that the secondary market for corporate bonds may have become less liquid because of changes in the regulations applied to commercial banks and because the largest commercial banks in the country have substantially increased the amount of capital they hold behind the assets of their trading operations. If these secondary markets have become significantly less liquid than they had been before the recent financial crisis, trading desks may have trouble moving assets around and adjusting their portfolios.
A big rush of new issues might just exacerbate this concern.
For now, however, the top executives of Verizon must be smiling all the way to the bank.
Gelles quotes Donna Hitscherich, a finance professor at the Columbia Business School as saying, "Timing is everything."
And, so it is! You betcha'...