Global investment grade corporate bond new issuance slowed markedly in the first half of 2021, compared with the record-setting year before, when cash was king and companies were desperate to show equity investors and bank lenders that they could still raise large amounts of term finance.
No one was criticizing them then for lazy balance sheets. Shareholders were just trying to separate companies with the resources to survive Covid lockdowns from those that might not. And the ability to access liquidity was critical.
This year, it all looks very different. Companies sitting on large piles of unused cash are likely to attract the attention of private equity bidders and shareholder activists.
A lot of risky companies look like they’re sitting pretty on cash from government guaranteed loans … but at some stage they will have to start repaying
According to data from Refinitiv, global high-grade corporate new supply was down 18% for the first six months of this year compared with 2020, though the $2.4 trillion raised so far in 2021 is still the second-largest first-half volume figure ever.
In the US dollar market, new issue volume fell 34%, compared with 2020.
But it is a contrasting story in high yield. New issues surpassed $400 billion for the first time, with primary volume up 52% compared with the first half one year ago. Issuers from the US, UK and China accounted for 75% of that volume in the first six months of 2021.
In July, with the delta variant of Covid already dominant in the UK and now spreading fast in the US, as well as parts of the EU, a new force appeared to be driving bond markets.
Rates on 10-year Treasuries, which rose in the spring on prospects of strong growth and inflation – and which most Wall Street analysts expected to hit 2% by the end of this year – were falling back once more, down below 1.3%, as investors worried about a slowing in the widely touted economic recovery if re-openings are delayed.
What are investors to do?
Nick Darrant, co-head of EMEA fixed income syndicate at Citi, says: “The hunt for yield has taken a grip on markets. Last year, central bank buying was the rising tide that lifted all boats and there were good returns across the debt market. This year, with rates tight and valuations high, it has been more of a challenge and the only asset classes with positive returns have been high-yield ones.
“That is not just high-yield bonds and leveraged loans themselves. Investors are looking down the capital structure to subordinated instruments from banks and hybrid bonds from investment grade corporates.”
There has also been a strong flow of money into emerging market debt, and new issues from emerging market corporates were up 4% for the first half, compared with the same period in 2020.
Darrant references the recent $12.5 billion four-tranche deal for Qatar Petroleum that generated $40 billion of demand and the $6 billion deal for Saudi Aramco in June that was 10 times covered. “The best performing tranches were the longer-dated ones that offer higher returns,” he says.
‘Clouds forming’
But if investors are packing their portfolios with longer-dated debt rather than shorter-dated, with junior instruments rather than senior and high-yield rather than investment grade, surely some will be hurt if the economy does recover and yields rise, and others will be hurt if new Covid variants disrupt the re-openings and downgrades pick up.
“The clouds are forming on the horizon and the punchbowl will be taken away at some point, and investors are thoughtful about this,” says Darrant. “But there is also a fear of missing out on spread compression if the recovery continues. Default rates have dropped and we don’t see that changing. For now, we expect the dynamics that have been driving primary markets to continue.”
High-yield issuers will want to sell new bonds when absolute rates are low and credit spreads tight before central banks taper their purchases.
George Curtis, portfolio manager at TwentyFour Asset Management, sounds a note of caution in a piece advocating greater investor selectivity, pointing out that 200 European high-yield issuers fully drew down their bank revolving credits in the first months of 2020. While just over half have repaid in full or in part, 97 have not even started to repay these yet.
Many of these are likely to be Covid-exposed businesses.
Curtis says: “While the vast majority of repayments so far have come from operating cash (74% of repayments to 1Q21), we believe the remaining fully drawn liquidity lines will possess a greater weighting to refinancings in the bond market than previously, as banks look to de-risk their exposure to these names and companies with high operating leverage take longer to generate the necessary cash flows after economies fully reopen.”
So, a potentially more risky cohort of supply is on its way.
Government support has helped drive down the rolling 12-month default rate among European high-yield issuers to 2.9%. And as the damage during the first half of 2020 now falls out of that number, it could hit 1% by the end of this year.
“While a 1% default rate looks benign and credit fundamentals are nearly perfect, conditions are unlikely to remain quite this good,” Curtis suggests in a masterful piece of understatement.
The bond markets should see a pick-up in the default rate in 2022 and beyond, given that Covid has allowed riskier borrowers to increase leverage, amid fiscal support from governments and technical support from central bank purchase programmes that cannot continue indefinitely.
A lot of risky companies look like they’re sitting pretty on cash from government guaranteed loans and delayed tax and VAT payments, but at some stage they will have to start repaying these and become self-sufficient again.
One EU-based banker tells Euromoney: “That’s when it will become clear how many of them were really in intensive care all this time. Not all of them will survive.”
