Marie Leone’s “Capital Ideas” column appears every other Thursday. Contact her at [email protected]
On September 30 the National Association of Securities Dealers released a report asserting that for their own protection, retail investors need more, and better, information about corporate bond pricing and transactions. NASD found that 60 percent of retail investors don’t understand the reverse relationship between bond prices and interest rates; 34 percent either believe that bond transactions are free or don’t know if they pay a fee to execute a transaction.
A day later — as if scripted in Hollywood — NASD launched the third and final phase of its Web-based bond transaction tracking system, TRACE (Trade Reporting and Compliance Engine). Today, the system provides investors with reports on 17,000 corporate bonds within 15 minutes of each trade; by February, TRACE will report on all 23,000 corporate bond issues.
For the NASD, retail investors were an obvious focus; its report emphasized that since institutional investors are more sophisticated and can bring greater resources to bear, they’re a lower priority for near-term action. Accordingly, retail investors “should be regulators’ immediate focus.” And indeed, noted NASD, 65 percent of corporate bond transactions are in quantities of $100,000 or less — a level generally acknowledged as representing an individual investor transaction.
Retail investors are increasingly the focus of senior financial executives as well. Since 2001, sales of new corporate bonds to retail investors have doubled to $25 billion annually, and the number of issuers has jumped from 6 to 36, reports investment back Incapital LLC, which specializes in the retail market. General Motors Acceptance Corp. (GMAC) has been the top issuer three years running; its 2003 bond sales of $7.1 billion represented about 28 percent of the total market for corporate debt issued to retail investors. Ford Motor Co. and General Electric Capital Corp. each sold about $3 billion that year (12 percent).
GMAC’s pole position may reflect its long experience in the market; in 1996 it became the first company to issue bonds to retail investors with a $300 million program structured by ABN Amro. Other well-known issuers to the retail market include Boeing Capital, DaimlerChrysler, IBM, Citigroup, and Protective Life Insurance.
For chief financial officers and treasurers, selling bonds to the retail market is attractive in a number of ways. Retail demand allows issuers to be more flexible with structure and maturity dates, says senior vice president Judy Wilson of Protective Life: “The granularity of the retail marketÂÂÂÂ helps smooth out the lumpiness of institutional issues.” And although retail issues don’t offer much of a discount on the cost of capital compared with their institutional counterparts, “they do put us in the market every week,” she says. They can also be parceled out in nonstandard maturities to help ladder a bond portfolio more effectively, says Wilson, who notes that “institutional investors charge extra for odd maturity dates.”
Protective Life started its retail bond program in January, issuing off a $3 billion medium-term-note shelf. The bonds are underwritten by Chicago-based Incapital and by Banc of America Securities. One to three series of notes are offered each week with an average size of $9 million per issue. The largest issue to date was an $80 million offering; the smallest, $750,000. Protective Life executes one trade with Incapital, and the investment bank handles the marketing, aggregates the orders, and pays out commissions to a network of broker-dealer firms that sell the bonds. The top 10 broker-dealers (by retail penetration) account for 70 percent of Protective’s retail bond sales, notes Wilson.
The bonds are priced at par and are sold in denominations as low as $1,000, says Incapital chief executive officer, Tom Ricketts — who was also a member of ABN Amro team that launched GMAC’s pioneering offer. Although some observers have questioned how well retail investors understand the risks of the corporate bond market, Ricketts points out that since the average retail sale is $20,000, the transaction is usually completed with the help of a sophisticated advisor.
Ricketts observes that retail investors tend to buy and hold bonds until the maturity date because they usually have a long-term investment philosophy, while institutional investors tend to put bonds out to bid in the search for the highest total return. By his lights, those opposing strategies are valuable in helping to diversify a company’s debt portfolio.