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Corporate-Bond Issuance Wanes but May Soon Wax
Companies and bond investors retreat in the face of volatile markets. But once the situation stabilizes, they’ll be back.
Count corporate-bond issuance as another victim of the recent volatility in global financial markets. The turmoil has caused a sharp drop in the number of U.S. investment-grade corporate-bond issues so far this year. But analysts and money managers dont think the issuance decline will be long-lasting, and in fact several blue-chip companies have already resumed bond sales.
Theres no doubt that once stability returns to the markets, issuers will go back and catch up, says Hans Mikkelsen, head of high-grade credit strategy at Bank of America Merrill Lynch in New York. The persistent mergers and acquisitions boom will help fuel issuance, as companies have plenty of deals to finance.
Thus far in 2016, through February 18, the number of investment-grade corporate issues has plunged 44 percent, to 38 from 68 in the year-ago period. The dollar volume has soared to $109 billion from $85 billion but thats largely because of one sale, last months $46 billion issue by Leuven, Belgiumbased Anheuser-Busch InBev to finance its takeover of Londons SABMiller.
The drop in the number of issues has come as stock markets around the world have plunged and then zigzagged up and down. The Standard & Poors 500 index was down 6.2 percent year-to-date through February 19, and the CBOE Volatility index has closed above 20 every day but two this year.
Unsettled markets have led to a widening of spreads between investment-grade corporate-bond yields and Treasury yields. The BofA Merrill Lynch U.S. corporate 710 year spread totaled 236 basis points on February 18, akin to recession-type levels in the past, says Scott Service, coportfolio manager of the Loomis Sayles Global Bond Fund in Boston. Thats up from 191 basis points at the beginning of the year.
The market turmoil and widening spreads have combined to keep issuers out of the market. Everyone goes to the sidelines when theres this kind of volatility, says Michael Collins, co-manager of the Prudential Total Return Bond Fund in Newark, New Jersey. Also, many companies are looking to reduce their leverage. He sees a turning point in the credit cycle in terms of corporate attitudes toward debt. Companies have high levels of debt, and declining earnings in some cases. Now they have to right-size their balance sheets by cutting debt, Collins says.
Investment-grade companies can issue bonds in these difficult conditions if they want to, but their borrowing costs will probably be cheaper in a calmer market. And many companies can afford to wait, market participants say. To the extent that issuers can control when they issue, they want the lowest rate possible, says David Sherman, president of investment firm Cohanzick Management in Pleasantville, New York.
The rocky environment discourages bond buyers too. A lot of investors are yield-sensitive, so they sit on the sidelines, Mikkelsen says. And when liquidity dries up as a result of the volatility, investors are worried about the availability of bonds they might like to buy, Service says
Interestingly enough, investment-grade corporate-bond yields havent moved much so far this year. The BofA Merrill Lynch U.S. corporate 710 year yield has traded up and down between 4 and 4.15 percent for most of that period, closing at 4.02 percent on February 18. The widening in spreads has stemmed mostly from a decline in Treasury yields. The ten-year Treasury yield slid to 1.75 percent on February 19, from 2.27 percent on December 31.
Corporate yields are still attractive for issuers, so once conditions stabilize, investors say they will return to the market. The issuance rebound may already be under way. Last week saw four of the ten largest investment-grade corporate issues of the year: Apple, $12 billion; IBM Corp., $5 billion; Comcast Corp., $2.25 billion; and Philip Morris International, $2 billion.
There is supply that has to get done, says Ron Quigley, head of the fixed-income syndicate at Mischler Financial Group. M&A announced last year and early this year account for much of that. Quigley predicts that $600 billion of issuance for M&A activity will hit the market this year.
Experts expect the M&A wave to continue, but some say companies will reduce their share buyback activities, because in many cases the repurchase programs havent succeeded in boosting stock prices. And fewer buybacks, of course, means reduced bond issuance to finance them. Typically, corporations focus more on bondholders than shareholders at this point in the credit cycle, Prudentials Collins says. Whereas he sees issuance recovering from the recent lull, he thinks the 2016 total will lag last years record haul of $793.6 billion.
But Mikkelsen of BofA Merrill Lynch doesnt expect a falloff. Just a few weeks of subpar issuance wont change our view, he says.