Big banks and brokers have been aggressively paring their holdings of corporate bonds over the past few weeks, Federal Reserve data shows, and market participants said risk-wary bankers are unlikely to rebuild them for a while.
Primary dealers — 22 banks and broker-dealers authorized to trade government bonds directly with the Treasury Department — held $54.62 billion of corporate debt with maturities beyond a year.
That sum, as of Thursday, was down 42.5% from May 25, according to the Federal Reserve Bank of New York.
Escalating concern about the European sovereign debt crisis and the flagging economy and political gridlock in the U.S. has led banks to take risk off their balance sheets and sell securities and loans that they held.
"Generally, we are in a more risk-averse world," said Randy Parrish, a high-yield senior portfolio manager with ING Investment Management.
The recent decline in banks' bonds holdings, of nearly $6 billion, was even sharper as dealers reacted to what is known as the Volcker Rule.
The rule, which came out of the Dodd-Frank Act, imposes stricter guidelines on banks' trading with their own money.
Banks have shrunk their holdings of corporate securities below levels at the depths of the credit crisis, and close to those last seen toward the end of 2002.
Back then dealers were busily building inventory, which peaked at close to $200 billion five years ago.
In addition to market declines, European woes, U.S. worries and regulatory uncertainty, memories of the credit crisis are also weighing on these financial institutions, which were forced to hold billions of dollars of toxic securities on their books because they couldn't find buyers.
Buyers weren't this fearful even earlier this year. Broker-dealers and banks had shored up their balance sheets and their appetite for risk had increased.
Debt issued by companies looked attractive at yields ranging between 4% for investment-grade and 7% for high-yield securities.
Further, companies had reduced their costs and increased their cash on hand, and were looking forward to growing with the economy.
On May 25, dealers held $95 billion — a year-to-date high — of corporate securities with maturities longer than a year.
Some credit analysts said they think that dealer inventory likely will remain at current levels for a while, and that this could weaken demand for issuance of corporate debt.
"The capital allocated to trading desks across all banks is being reduced," said Jim Leonard, bank and corporate credit analyst at Morningstar Inc.
"When volatility goes up, the allocation amount goes down," Leonard said.
Now, even if dealers buy bonds they consider safe, they are unsure how the bonds would fit within the definitions of the Volcker Rule. Because of this uncertainty they are hesitating to make commitments.
"We are going to be around this level for a while, at least a year," Leonard said.
