The speed with which investors have dived into a new type of retail offering has surprised institutional investors, but it's also got them eyeing the possibility it may soak up excess supply and tighten spreads. In the last four weeks, Bank of America Capital Management has sold $600 million of the new InterNotes, part of a $3 billion shelf, and Household International is also planning a $1 billion issue. "I'm really surprised they've been able to place this much paper so quickly," says Robert Hickey, head of fixed income for Van Kampen Investments in Oakbrook Terrace, Ill.
Large household names, the target issuers for InterNotes, may diversify out of the institutional market, causing secondary spreads to tighten. "If the market continues to be as deep as it has been, we will see spreads tighten for existing BofA paper," says James Kelligrew, head of high-grade sales for the Charlotte, N.C.-based bank. He believes it is too soon to tell by how much spreads could tighten, but adds that "if demand is as deep as it appears, we could diversify away some from the institutional market." Based on this assumption, Gary Goodenough, portfolio manager at Mckay Shields in New York, considers InterNotes "a real benefit for [institutional investors] as some of the supply from frequent investors will be removed." "Issuance would have to approach the $2 billion mark before it would impact spreads," says Bruce Foster, v.p. of capital markets for Household, adding that the company will issue more InterNotes in the future. "This type of paper is an especially easy fit for financial services companies with continuous funding needs."
InterNotes are the result of a joint venture between BofA and Chicago-based Incapital, who act as joint lead managers, offering fixed coupon bonds on Monday morning to retail dealers who offer the bonds to individuals at par. The following Monday, after adding up the orders, BofA sells the bonds to Incapital at a discount. Incapital then sells the bonds to the retail desks at a smaller discount, who turn around and sell the bonds to individuals at face value. "The notes could be applicable not only to high grade, but also benchmark high yield and even agency paper," says Kelligrew, adding there should be an announcement of another InterNotes deal in the next three to four weeks. The deals will likely be announced in monthly blocks and amount to $1-3 billion in total, he adds.
"This is a really smart move. There is all this demand for fixed income from retail investors that want to preserve their wealth--we haven't seen this in 20 years," says Karen Kelleher, portfolio manager at Conning Asset Management in Hartford, Conn.
According to the Federal Reserve, household accounts hold $600 billion worth of corporate bonds, says Thomas Ricketts, president of Incapital, "and demand will increase exponentially as investors find it easier to buy the paper." Calls to Household were not returned.
Kathleen Shanley analyst at Gimme Credit, says a lot of people in the industry are experimenting with new ways to expand distribution to a retail client base, adding that if BofA and Household are successful, it is likely to open the floodgate to new issuers.