With counterparty-risk fears and capital hoarding still clogging the traditional sources of funding for companies, it could be a good time for investment-grade corporates to consider a debt market that has flown below the radar: corporate bonds bought by individual investors.
As of April 1, Incapital LLC, a Chicago investment bank, had sold $201 billion of retail corporate bonds since 2000 ($102 billion of which is outstanding), through a web-based platform it calls “Internotes.” The platform has been used by three agency issuers and 41 corporate issuers. One of them, HSBC Finance, has raised over $16 billion through this channel since 2001.
In February, Incapital gobbled up LaSalle, which sold a similar product called “Direct Access Notes,” and is now competing with Merrill Lynch, which offers CoreNotes. Tom Ricketts, Incapital’s founder, contends that retail bond investors can be extremely desirable to corporate issuers because such investors demand low maintenance: “They buy and hold and they don’t call you.”
They are also hungry for yield. With yield premiums on investment-grade bonds at about 274 basis points over Treasuries, according to the Merrill Lynch U.S. investment-grade corporate master index, corporate bonds offer investors great relative value, Ricketts says. For companies, it also may get cheaper to fund via debt markets next week, as futures markets are forecasting an 82 percent chance that the Federal Reserve will lower the Federal funds rate 25 basis points to 2 percent.
Why take the trouble to try to sell bonds to the person on the street rather than a portfolio manager? GE has raised about $9 billion through the Incapital distribution network since 2003, Chris Coffey, director of global long-term funding at GE, told CFO.com. “It’s a way to further diversify our source of funds,” he says. GE uses the channel to post maturities that it needs from an asset-liability management perspective but that are not easily sold in the institutional market.
Of course, unlike institutional issuances, there is no hard-coded guarantee that the company will raise a set amount of capital by a set date. And, importantly, the investment-grade company selling retail must have name recognition among the average investor.
The retail channel is also size-constrained. The largest amount Incapital and its brokers can move in a week is about $1 billion, Rickets says.
That doesn’t seem to bother GE. There are “no hard-and-fast [funding] targets,” Coffey says. “It’s quite nice to have as a complementary source of funding.”
GE offers debt continuously for about 45 weeks out of the year, Coffey estimates. This week it posted a three-year noncallable note with a coupon of 3.75 percent and a 16-year note, callable in four years, with a coupon of 5.75 percent.
Once a company like GE posts the available maturities each week, Incapital buys at a discount the amount of bonds it thinks it can sell and then resells them to brokers at a slight premium. Brokers sell the securities to retail investors at par value. About 800 firms sell the product, typically in blocks of $10,000 to $50,000 to each client.
When the all-in funding cost is calculated, the retail market is about the same as the institutional market, Coffey says. Since issuers are raising capital in smaller amounts, they tend to be more aggressive on yield, Coffey says. However, retail brokers get paid higher fees than the institutional variety.
On the other hand, it’s because they’re an alternative to the institutional market that companies are seeking out retail investors. Every dollar a company puts into the retail bond market is one less dollar they have to raise in the institutional markets—where in the current difficult fund-raising environment it may have to pay a 25 to 50 basis point new-issue premium. “It removes some of the cost of overall funding,” Ricketts contends. “Individuals only look at yield” for these bonds.