I am someone who regularly peruses the list of the latest new issue corporate bonds. On occasion, I find a bond that I immediately want to purchase when it begins trading on the secondary market. But most of the time, I end up finding bonds that I want to add to a watch list to purchase on a pullback. As corporate bond spreads have narrowed significantly over the past year or so, especially in the high-yield (JNK) part of the market, it is becoming rarer for me to find any new issue corporates that excite me. Regular readers of my articles may remember the frequency with which I used to discuss new issue bonds. It has now been a few months since I last mentioned the latest new issues coming to market.
Late last week, a bunch of well-known corporations priced brand new corporate bonds. According to Bloomberg, Friday of last week was the busiest Friday of the year for corporate bond sales. Sales of $15.1 billion were led by Verizon (VZ) with $4.50 billion, Microsoft (MSFT) with $2.25 billion, and Aetna (AET) with $2 billion. But there were also other notable offerings not mentioned in the Bloomberg article, linked above, such as Stanley Black & Decker's (SWK) $800 million of 10-year notes and General Dynamics' (GD) three-part $2.4 billion offering (notes maturing in 2017, 2022, and 2042).
Despite several companies that I consider acceptable credit risks offering new corporate bonds, the list left me quite underwhelmed. I couldn't find even one bond I was interested in adding to my watch list, let alone interested in purchasing at today's price. The reason I don't want to purchase any of the issues sold by the aforementioned companies has to do with the combination of today's extremely low yields and spreads that are, at best, only moderately attractive. But why wouldn't I at least add a few of the notes to a watch list to consider purchasing in the future?
The reason I am not even interested in adding some of the newly issued corporates to my watch list of bonds to purchase is because the coupons are simply unacceptably low. To best illustrate how low the coupons are, take a look at the coupons on the 30-year bonds issued last week. Microsoft issued its 30-year with a coupon of 3.50%; General Dynamics' 30-year checked in at 3.60%; and Verizon's and Aetna's 30-year issues have coupons of 3.85% and 4.125% respectively.
As I am sure you can imagine, the coupons for the newly issued shorter duration notes were far worse. Let's look at a few examples. General Dynamics issued a 5-year note with a 1% coupon, but Microsoft topped that with a 0.875% coupon on its 5-year note. Verizon's 10-year note was issued with a coupon of 2.45%, Aetna's 10-year came with a 2.75% coupon, and Stanley Black & Decker got the closest to 3%, with a 2.90% coupon on its 10-year note.
Given these incredibly low coupons, should investors completely ignore the companies mentioned in this article when searching for bonds to buy on the next pullback in price? No. Instead, investors searching for higher income should be building their watch list with a focus on previously issued bonds with higher coupons. These bonds are most likely currently trading over par but will work their way back toward par should yields rise.
For example, Microsoft has two longer-dated bonds with 4.50% and 5.30% coupons maturing in 2040 and 2041 (CUSIPs 594918AJ3 and 594918AM6). On a pullback in bond prices (rise in yields), these would be the bonds to focus on if you are interested in longer-dated Microsoft bonds and higher yearly income. General Dynamics offers a 2021 maturing note with a 3.875% coupon (CUSIP 369550AR9). This would provide more yearly income than its recently issued 2.25% coupon 10-year note. Verizon also offers a 2021 maturing note with a coupon higher than its newly issued 2.45% 10-year note. The 11/1/2021 maturing note (CUSIP 92343VBC7) comes with a 3.50% coupon.
If you do find yourself adding higher coupon bonds to your watch list for the next pullback in corporate bonds, keep this in mind: Depending on how high the coupon is and the extent of the next pullback in corporate bonds, the notes on your list might not get to the point where they trade at a discount to par. You therefore might end up purchasing bonds trading at a premium to par. There are a few things worth understanding before purchasing bonds trading over par, and my article, "3 Things to Consider When Buying Premium Bonds," should be a good starting point for your research.
Also worth remembering is that it is not uncommon for companies issuing new corporate bonds with lower coupons to use the proceeds to call in bonds with higher coupons. Sometimes they can force a call according to the call provisions of the note, and other times, they simply make tender offers hoping that the premium they will pay is enough to entice investors to redeem the higher coupon bonds. In either case, the longer yields stay at historically low levels, the more difficult it will be, over time, to find higher coupon bonds.
This means that if we experience many more years of historically low yields, investors with bonds maturing in the coming years will struggle to replace those bonds with comparable coupons. And if companies are successful in replacing most of their higher coupon bonds before rates head higher and also successful in extending the duration of their debt, it may leave less of a need to issue new debt when rates start heading higher. This would only exacerbate the challenge for bond investors seeking higher yearly income. For recent commentary on the prospect of yields staying low for an extended period of time, consider reading "My Biggest Fear As A Bond Investor."