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Volatility Dampens, But Doesn’t Deter, Bond Issuance

Rates remain low and demand is high, particularly as M&A chugs along. Issuance will rebound, unless market turmoil returns

The recent turmoil in financial markets has dampened investment-grade corporate bond issuance, with three companies canceling or reducing planned issues in a single day last month.

But unless the volatility returns in a sustained way, issuance will rebound, though not to the record levels of the past year, analysts predict. They say that the environment is now favorable for issuance and that many companies need financing in any case.

Only 49 issues came to the market in September, down from 87 a year earlier, according to Dealogic. “Definitely, the increase in financial market volatility has an impact on the amount of issuance,” says Richard Wolff, head of investment-grade bond syndicate for Société Générale in New York. On September 28 Santander Holdings USA, a subsidiary of Spain’s Banco Santander, and Chattanooga, Tennessee–based shopping center owner CBL & Associates Properties bailed on their bond sales. In addition, Los Angeles, California–based Westfield Corp., another shopping center company, trimmed the size of its debt offering.

Those companies that did execute bond issues during the tumult, such as Palo Alto, California’s Hewlett-Packard Co. and Houston–based Enbridge Energy Partners, had to offer much larger than normal concessions to investors, Wolff notes. But if financial markets remain calm, new issuance could surge, as “a lot of people try to go through a tight window,” he says.

New York–based Hans Mikkelsen, head of high-grade credit strategy at Bank of America Merrill Lynch, thinks volatility won’t spike again soon. Investors were rattled after the Federal Reserve’s September policy meeting, he says, because officials emphasized global economic weakness in their statement yet said in the following days that a Fed rate hike was probably coming in any case. “That made the situation for investors uncomfortable,” Mikkelsen says. What has changed since then is that the September jobs report showed that global weakness is having a real impact on the U.S. economy, he says. “So it becomes less likely the Fed will hike interest rates anytime soon.”

That leaves a perfect backdrop for investment-grade corporate bond issuance, Mikkelsen says. “The U.S. economy is inherently strong [BofA sees 2.8 percent growth this quarter] and can manage the global economic weakness. But you don’t have to be concerned with the Fed moving aggressively to hike interest rates. That’s a better environment for risk assets.”

So it’s no wonder that credit spreads already have begun to tighten, Mikkelsen says. The spread of investment-grade corporate bonds over Treasuries totaled 177 basis points Tuesday, down from 180 basis points Friday, though still above the 158 basis points that prevailed August 5, before all the market turmoil began.

Bruce Falbaum, a principal at money manager Cohanzick Management in Pleasantville, New York, agrees with Mikkelsen that “the market seems to have gotten a reprieve from the Fed. As a result, companies that thought they missed the window [to issue bonds] may come back.”

As for financial market volatility, “It is having some impact on issuers who might consider issuing for a nice-to-do,” he says. “In other words, it would be ‘nice to do’ for buying back stock or paying dividends.” The volatility has given those companies a reason to pause, Falbaum says. “But that won’t slow down folks who have to get a deal done.”

There are plenty of companies that have agreed to mergers, such as Israeli drug maker Teva Pharmaceutical Industries and Houston oil field services titan Halliburton Co., that need to issue bonds to finance their acquisitions, he says. Teva is buying Allergan’s generic business for $40.5 billion, and Halliburton is purchasing crosstown rival Baker Hughes for $35 billion.

“These are deals that need to be finished by the end of the year,” Falbaum says. “There’s been a significant increase in mergers and acquisitions. Unless a deal gets killed because it’s too expensive, [acquiring companies] will pay an extra 15 to 20 basis points on their bonds to get the deal done.”

To be sure, some companies issued bonds earlier this year to lock in low rates in anticipation of a Fed rate hike, which some analysts argue will limit issuance in coming months. But “we will continue to see supply, despite a challenging environment for issuers to navigate,” Société Générale’s Wolff says.

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