On Monday morning, I was sitting at my computer following the prices of various equities, options and fixed income products. In the 11 am EST hour, I turned my attention to a Chesapeake Energy (CHK) corporate note (CUSIP: 165167CG0), maturing February 15, 2021, with a 6.125% coupon and a make whole call.
At 11:20 am, there were 95 bonds being offered at 99.20 cents on the dollar (it had been that way for several minutes) when all of sudden, a completed trade was reported: a "Customer Buy" of 40 bonds at 101.173. I could only shake my head. Less than one minute later, an execution of a "Customer Buy" order for just 5 bonds was reported at 99.20/99.30 (Simultaneous Dealer-to-Dealer/Customer Buy). Then, seconds after that, at 11:21 am, another order was reported. This one, a "Customer Buy" order for a massive $1 million+ got filled at 99.75. All the while, the offer in the market remained at 99.20.
That's the over-the-counter corporate bond market for you. Within 60 seconds of each other, a retail investor got $5,000 face value of bonds filled at a yield-to-maturity (YTM) of 6.227%, while the investor buying $40,000 face value got filled at a YTM of 5.955%, and the investor buying more than $1 million worth of the bond gets a YTM of 6.161%. So why didn't the customer buying 40 bonds get filled at 99.20? After all, there were 95 bonds being offered at the time. Furthermore, why wasn't the customer purchasing $1 million+ face value of the CHK bond able to secure a better price than the retail investor buying just $5,000 face value? In the world of corporate bonds, a world dominated by over-the-counter trading, who your broker-dealer is matters.
Whether it be through the markup a broker adds to a bond, the commission a broker charges, or simply the type of access a broker has to inventory for a bond, it is incredibly common for investors to pay vastly different prices almost simultaneously on individual corporate bonds. This is true both in liquid issues like the CHK bond mentioned above as well as in illiquid issues.
Chesapeake Energy was not the only company I found on Monday with corporate bond orders being executed at wildly different prices within minutes of each other. Computer Sciences' (CSC) March 15, 2018 maturing, 6.50% coupon note (CUSIP: 205363AL8) with a make whole call and conditional puts for change of control is another example of a liquid corporate bond where one can spot huge markups being applied to current offers in the secondary market. On Monday, January 23, at 11:11:27 am EST, there was an instance of a dealer-to-dealer transaction of 30 bonds at 100.72, which occurred simultaneously with a customer buying 30 bonds for 103.095. In terms of yield, the difference between the two prices equates to 46.5 basis points. There are many other instances on Monday alone of huge markups that can be found in this particular CUSIP. I also found an example of a customer buying 25 CSC bonds at 101.532 (4:20 pm EST) at the exact same time as there was an offer to sell a minimum of 20 bonds at 100.99.
Alcoa's (AA) decently liquid corporate note (CUSIP: 013817AV3) maturing April 15, 2021 with a 5.40% coupon, routinely saw sell orders being executed at prices below the best bids the corporate bond market was showing on Monday. Minimum quantities were not the reason for the lower sell executions, as the executed orders I am referring to were of greater quantities than the minimums on the bid side. Alcoa's corporate note (CUSIP: 013817AK7) maturing February 1, 2037 with a coupon of 5.95% provides a great example of a dealer marking up a bond by nearly two cents on the dollar, buying from another dealer at 99.122 (6.018% YTM) and simultaneously selling to a customer at 101.022 (5.871% YTM). There were cheaper alternatives available for the customer in the secondary market. This particular example occurred despite no offers I saw for this bond on Monday anywhere near 101.
U.S. Steel's (X) corporate note (CUSIP: 912909AF5) maturing April 1, 2020 with a coupon of 7.375% provides an example from Monday of a customer purchasing at a price of 102.50 $100,000 face value of the note at exactly the same second (2:16:40 pm EST) the broker purchased the notes from another dealer at 101. When I occasionally checked the offer prices for that U.S. Steel note throughout the day, I never saw it above 101. The markup the customer paid was $1,500, compared with paying as little as $100 in commissions with no markup and lower offer prices at other brokers.
As a final example, JPMorgan Chase's (JPM) non-callable corporate note (CUSIP: 46625HHZ6) maturing May 10, 2021 with a 4.625% coupon traded as high as 104.019 on Monday. This occurred despite all the offers I found in the secondary market ranging only from the upper 101s to lower 102s. At 12:12:21 pm EST, there is another example of a $100,000 face value customer purchase with a large markup. This customer bought 100 bonds at 103.665 at the exact same second the broker-dealer purchased the bonds for 101.915.
So what should investors do with this information? If you are not concerned about the price you are receiving relative to prices being offered in the market and are happy with the yield and price your broker is offering, even if the bond is being marked up, then you would simply make the purchase at the price your broker is offering.
If, however, you are concerned about the price you are receiving on your individual corporate bond purchase, the first thing you should do after seeing the offering price from your broker is check the latest prices the bond has traded at. I always like to check the prices for the day I am making a purchase as well as check the prices for several days prior. Your broker should be able to provide you with this information. If your broker cannot provide this information, use FINRA's website to get a complete list of trades on the CUSIP you are interested in. If you have multiple brokerage accounts, check the current offers on the CUSIPs you are interested in at each of your brokers. You can even consider calling your broker and asking him/her to check Bloomberg for additional offers you might not be seeing at the moment.
If, after doing all of this, you are not happy with the offer your broker is giving you, there is the option of asking the broker to enter an order into the market at a limit price of your choosing. I have done this on many occasions and, depending on the broker, have had varying degrees of success getting executions.
In closing, I would like to make it clear that the point of this article is to help retail investors, who might not have known otherwise, understand that the over-the-counter corporate bond market has wide discrepancies in both bids and offers depending on the source used to execute orders. Furthermore, this article is meant to inform retail investors that if they discover a broker is marking up securities to an extent that seems unreasonable or charging commissions that seem unreasonable, there are likely alternatives that can be pursued. Good luck and happy investing!
Disclosure: I am long CSC. I am long CUSIPs 165167CG0, 013817AV3, and 912909AF5. I am also long JPM bonds, although not the CUSIP mentioned in this article.