Bargain Basement Borrowing Costs Spur Record Issuance
Historically, the month of August has been associated with such phrases as “the dog days of summer” and “those lazy, hazy, crazy days of summer.”
This year, however, someone let the “dogs” out, and the days were just “crazy” in terms of corporate bond issuance, across all asset classes.
Over the past decade, the month of August has consistently ranked as the second slowest high grade ex-SSA issuance month of the year, averaging a mere $69.684bln in ex-SSA high grade issuance.
As a matter of fact, coming into this month, despite the extenuating circumstances that have caused all forms of corporate issuance to literally explode this year, the Street was so convinced that this August would be no different from those that had gone before that the highest ex-SSA high grade issuance estimate came in at $71bln.
Well, this year is certainly “different” than any other year – we have already set a new annual ex-SSA issuance record of $1.421.135bln, 83.1% higher than last year at this time, with four months remaining. The previous record was 2017’s $1.335.363bln.
And, when it comes to this August, the same holds true. This year 100 borrowers raised an unprecedented $139.984bln during the month of August, shattering the previous August issuance record of $114.873bln set back in 2016.
Unprecedented indeed. For the fifth consecutive week, the respondents to our weekly issuance poll underestimated the determination of sellers to refinance more expensive outstanding debt, stretch out the liability side of their balance sheets, beef up liquidity in light of the uncertainty surrounding the duration of the virus and its adverse impact on the economy, and take the opportunity, when presented, to finance new or pending M&A activity, while borrowing costs remain historically low.
That's not to say market pros have lost their edge when it comes to predicting pending issuance. It's just that their weekly estimates, by their own admission, have been more educated guesses, than well planned out strategies.
What makes this month’s performance even more remarkable is that all this was accomplished during a month that was punctuated, more than once, by outside, market moving influences: Tropical Storm Isaias and Hurricane Laura; the stalled negotiations in Washington over additional stimulus; the continued spread of the coronavirus; an ailing jobs market; intensifying social unrest; the seemingly never ending tensions between the US and China; and an upcoming contentious presidential election.
However, through it all, corporate borrowers forged ahead with their capital raising plans. According to a recent research report from Bank of America, “The recent re-steepening of the curve, election risks and perceived risk of a second wave of infections are only accelerating refinancings, pulling issuance into August.”
“Strong demand has encouraged issuance," said one senior credit strategist. “Investors are continuing to buy high-grade bonds because, even as yields are at, or near, historic lows, they are still offering better returns compared to expensive equities and similar fixed income instruments around the world."
He added, “The recent weakening in the US dollar has also helped lower cross currency hedging costs for overseas investors who are also back buying high-grade bonds attracted by the net yield pickup which after all costs is meaningful now."
That increased foreign buying interest only added to what some might call a feeding frenzy in the US corporate primary market throughout the month. Not only did we see some familiar names returning to the market for second, even third helpings, in light of the uncertainty of the coronavirus situation, we also began to see infrequent, less than household names start to tap the debt market, and they too received solid receptions. So, as the seller and buyer bases expanded, issuance continued to flow freely.
No one should really have been surprised by the flow of issuance this month, since it made perfect sense for corporate borrowers, especially those who had their hands tied by earnings blackouts earlier in the month, to take full advantage of relatively low borrowing costs to replace more expensive debt and to extend maturities further out on the curve, while adding to, or bolstering, their cash positions.
If you were an A-rated company looking to issue 10yr securities at this time last year, you would have probably had to pay roughly 4.00% to do so. If you had been looking to print a similar transaction in late March of this year, you would have paid close to 5.00%. However, today, that same sort of deal would only cost you around 2.00%, if that.
Looking at the numbers, it's no wonder that we have seen a resurgence in high grade corporate issuance of late, despite the recent sell off in the Treasury market – the benchmark 10yr note yield rose nearly 19bps this month, though corporate spreads tightened 4bp.
It didn’t hurt that we saw a resurrection of sorts in M&A-related capital raising transactions. This month saw its fair share of M&A-related transactions.
In general, M&A activity has been subdued this year as companies focused on survival amidst the pandemic crisis. But now, as lock downs are easing and life, as we once knew it, makes a valiant attempt to get back to normal – well, at least a “new” normal - companies are beginning to look at inorganic growth opportunities.
Or, at the very least, taking on the role of either “white knight” rescuing, or “vulture,” preying on - your call - those less fortunate companies, who just couldn’t seem to make it through the COVID-19 crisis.
However, after adding $18.569bln to the M&A funding tally this month – the first since the last week of June, the year-to-date M&A-related volume now stands at nearly $77.419bln.
In comparison, at this time last year M&A-related issuance stood at roughly $140bln, and $177bln in 2018. While M&A volume has picked up of late, it may take a while before volumes generated by M&A-related transactions claw their way back to the heady levels seen in recent years, with most focusing on contending with the pandemic.
“There is definitely more emphasis on the good news and I think people are being hopeful," said one syndicate manager. “There’s no question that the financial markets are being propped up by a string of generous stimulus packages, though Congress is still haggling over the latest installment and President Trump has issued an executive order extending coronavirus relief, prompting legal action - and a liquidity backstop for debt that has been the main driver of demand in the US high-grade bond market.”
The stimulus packages have broadly helped, as has the underused liquidity backstop from the Fed, in ensuring larger companies that employ thousands of workers have had access to liquidity and appear to be able to get through the COVID-19 crisis.
With corporate balance sheets apparently in better shape than some had initially thought, according to a Bank of America research report, there are those who believe that, while borrowing costs remain at bargain basement levels, more and more corporations decided to, and will continue to, take full advantage of the situation.
That has resulted in a resurgence in issuance, which is expected to continue. Nothing like we saw last quarter mind you, but substantial all the same. Especially if the COVID-19 business restrictions last much longer.
Many businesses have already written off the rest of the year and have set their sights on 2021, and the hopes of a viable vaccine, which should ease the pandemic restrictions.
With some strategists predicting that this year could see as much as $1.6trln in high-grade new issuance, the expectations are that a steady flow of issuance will continue in the coming weeks and months. “We expect $120-140bln of issuance in September, mostly refis,” said the Bank of America report.
While decent, it pales in comparison to what last September produced ($160.6bln). Over the past decade, the month of September has consistently ranked as the busiest issuance month of the year producing, on average, $122bln, so that estimate seems to be right in line.
Some seem to think the upcoming election may stunt issuance next month. However, a look back at issuance volume in the month of September preceding past presidential elections shows us that, prior to the last two elections, the month of September produced the second largest amount of monthly issuance for those respective years - $109.251bln/2012 and $147.284bln/2016.
Due to the barrage of coronavirus-induced investment grade issuance - $1.1trln since the March 23 – market players were forced to revise their annual ex-SSA issuance outlook from a beginning of the year $1.093trln average estimate to a more realistic $1.6trln.
Well, with $1.421trln already on the books, and a respectable $130bln expected to come to market next month, reaching that plateau should be a layup. As matter of fact, with four months remaining in the year, that $1.6trln could realistically be a bit on the short side.
It should also be noted that (SSA-inclusive) overall issuance also set a new monthly issuance record in August, with $164.584bln crossing the tape, breaking the old August record of $141.513bln set back in August of 2016, and bringing overall issuance year-to-date to $1.702.610bln, more than enough to set a new all-time annual overall issuance record, topping 2017’s $1.661.000bln.
High Yield Follows Suit
But the cavalcade of corporate issuance this month was not just limited to the high-grade market. We saw the same kind of interest in the high yield market.
While issuance tapered off toward the end of the month, August HY issuance volume came in at $52.925bln, ranking it as the second busiest issuance month on record behind the all-time monthly high yield issuance record of $58.235bln set in June.
August played host, not only to the busiest high yield issuance week of all time (week of 8/10 - $22.4bln), but the third as well (week of 8/03 - $21.065bln).
While the month of August may have come close to unseating June as the busiest high yield issuance month on record, year-to date high yield issuance, despite topping last year’s year-to-date total by 74.3%, still only ranks as the seventh heaviest high yield issuance year of all time at $285.875bln.
The surge in high yield issuance is just yet another indirect consequence of the Fed’s late March promise to backstop corporate debt. The central bank has promised to support some junk-rated borrowers, provided they were investment grade rated prior to the pandemic outbreak in late March.
That brought into play “fallen angels,” those downgraded from investment grade to junk status, resulting in elimination from some indices and the funds that track them, requiring high grade portfolio managers to divest of them.
“Although a downgrade represents an increased risk of default, if issuers can arrest some of the business pressures they face, fallen angels can end up being relatively high-quality bonds that everyone in the high-yield market wants to own, as some of them will be candidates for an upgrade to investment grade in the future,” said one such portfolio manager.
The downgrades, of which there have been 35, totaling $31bln since the pandemic outbreak, that have occurred came mostly from overleveraged companies in sectors most directly affected by the pandemic —autos (F), energy (OXY), airlines (DAL), and retail (M).
But given the dire economic environment, that too led to the increased issuance in August, and is expected to lead to even more issuance going forward.
High grade yields have plummeted this year as the result of Fed support, pulling junk-bond yields down with them. Though not a “fallen angel,” beverage-can manufacturer, Ball Corp, rated BB+, sold $1bln of 10yr bonds this month with a coupon of 2.875%, the lowest coupon ever for any high-yield bond maturing in more than five years.
That without even qualifying for Fed support, since it was already junk-rated prior to March 23. But, it’s just another example of the demand for high yield paper which is in turn, prompting increased issuance.
Estimates have as much as $400bln worth of “BBB-rated” bonds at risk of downgrade to junk as a direct result of the pandemic. That works out to be roughly 6.5% of the $6.1trln US investment-grade corporate market and nearly 14% of the $3trln “BBB” market.
Much like its high grade cousin, the high yield market is expected to see higher than expected September issuance as more and more companies look to raise cash to help them weather the storm that is the effects of the coronavirus.
Additionally, other companies are expected to take advantage of low borrowing costs to refinance existing debt. Among those expected to tap the market next month could be Delta Air Lines, which is said to be preparing an offering backed by its frequent-flyer program to help boost liquidity amid the Covid-19 pandemic.
Over the past decade, the month of September has yielded, on average, $27bln in high yield new issuance. This time around, given the uncertainty surrounding the long-lasting economic ramifications of the pandemic, issuance next month is expected to come in more around the $35bln area, according to an informal canvassing of market participants. To put things in perspective, high yield issuance has been averaging $35.735bln a month this year.
Shankar Ramakrishnan, Peter Knapp & Chris Buccat contributed to this article