The start of the bank earnings season means an opportunity to survey the smoking ruin of 2022 in capital markets.
The early signs – based on the US firms that had reported at the time of writing – is that debt capital markets revenues are set to post drops of 40% to 50%, equity capital markets something closer to 75% and advisory about 25%.
The unfamiliar picture of rising rates left some asset classes in tatters: global high-yield issuance collapsed 80% in 2022.
Capital markets bankers must hope that there is a healthy dose of capitulation among issuers in 2023. They may get their wish, or at least an improvement over the past 12 months.
Human beings have a natural bias to the familiar, and so there is an understandable myopia in parts of the debt market
Some businesses have come out of the blocks like their lives depend on it: take European financial institutions, which posted a blistering $82 billion of issuance in the first two weeks of January – there hasn’t been a new year like that since the global financial crisis (GFC).
FIG is an asset class that, more than most, waxes and wanes with the regulatory tide. This time the drivers are tweaks to capital rules and the latest slug of repayments of what was borrowed under the third targeted longer-term refinancing operation (TLTRO III) from the European Central Bank.
Jittery conditions last year also put paid to much of the usual pre-funding – there is some catching up to be done.
Some corporates would do well to learn from the example. As 2022 rolls into 2023, the elephant in the room is the urgent need for many lower-rated companies – from the small to the very big – to pay close attention to their capital structure.
New pricing
If there is one over-riding theme for the year ahead it is that borrowers will have to face up to what they have in large part been avoiding for much of the last year: that they must come to terms with a new pricing reality.
Those that got used to borrowing at 1% must get used to 5% – and that is for the better names. And the increases haven’t stopped yet.
Human beings have a natural bias to the familiar, and so there is an understandable myopia in parts of the debt market; what seems clearest to issuers is the recent period of low rates; longer-term norms seem blurred by comparison.
It has been a similar story in equities: investors’ views of valuations warped by the heady days of 2021.
In that sense, a new year brings a useful opportunity to reset. The reluctance of investors to put money to work late in a year – for fear of jeopardising year-to-date performance – is well known. Now there is a chance for issuers to reassess their viewpoint too.
Bankers are telling any client who will listen that it is the 12 months just ended that should be their reference point, not the crazy two years before that – or, for that matter, the crazy decade before that.
Will borrowers jump? Again, recent history is a poor guide, given how many have been able to bide their time during the first year of the rate-hiking cycle.
Largely unthreatened by any maturity wall and having in many cases raised pots of (often unneeded) cash when the coronavirus pandemic struck in 2020, the best rated corporates have been able to sit it out.
In this sense the downturn last year was different to the beginning of Covid or the teeth of the GFC, because borrowers had termed out their debt while the going was good.
That will change: maturities are looming in 2023 and 2024. And while there is plenty of debate around terminal rates – the highest point in a rate cycle – there is little doubt about one aspect of the longer-term horizon. Whenever rates stop rising, they will stay high for a long time.
And when they finally fall, it will not be to zero.
Recession risk
For those reasons, while last year was a down-year for corporate investment-grade issuance, this year is expected to be different. Investment-grade fund flows were negative in the first half of 2022 but turned positive later in the year, and there is plenty to be deployed.
Much depends, of course, on recession risk. Some bankers reckon that the pessimists have it wrong, that Europe’s recession, if it comes, might be shallow. The US might avoid it altogether.
When it comes to the outlook for inflation, there are certainly indicators that support the optimists: freight rates are falling, inventories are down, demand is weakening, labour markets are easing (the UK is a notable exception).
So far, corporate investment-grade activity is lower than the same period in the last four years. High-yield issuance is practically non-existent.
If the pessimists are right on the macro picture, then many companies will only see worse pressure on their top lines while struggling with debt burdens built up when times were easy.
At some point, reality must set in. Borrowers must accept where the markets now are. The worst-rated must give serious thought to their ability to cover their interest payments.
IPO activity might be minimal for a while longer, but the re-equitization of many balance sheets must be top of the agenda in 2023.