The changing dynamics of the corporate primary market
23 October 2009
Back in July, while some market participants questioned whether the corporate bond issuance bubble was about to burst, we argued that the stage had been set for a fundamental shift in the way companies fund themselves, and that thriving corporate primary market activity would continue (see previous blog). This has overwhelmingly proved to be the case. Year to date, around €283bn of €-denominated non-financial bonds have been issued, 175% higher than the amount issued in 2008, and far higher than the annual issuance in any year for the past eight. A key driver of this has been the rationing of bank lending activities. Dealogic data show that global bond issuance from non-financial companies has been over 20% higher than corporate loan volumes year to date, the first time this has happened since its records began. Companies have also been keen to reduce their reliance on the short-term commercial paper markets and swap to longer-term financing which is more readily available in the bond markets. This activity has been supported by investors’ search for yield in a low interest rate environment. Indeed, many new issues have been several times oversubscribed as corporate bonds have become the asset class of choice. The majority of €-denominated non-financial issuance this year has been from the more defensive utility and energy companies, accounting for around 25% of the total, perhaps reflecting investor caution in the first few months of the year. And interestingly, the average size of bond offerings has also increased, as companies have moved to hoard liquidity in light of strong investor demand.
Chart 1: YTD €-denominated bond issuance by sector
Source: Dealogic.
However, as 2009 progresses, we are seeing the dynamics of the corporate primary market change. While bond issuance immediately post-Lehman was dominated by high quality names, the past few months have seen more and more high yield names enter the markets. We view this as a function of both the easing in credit spreads and increasing investor risk appetite as the search for yield takes precedent. Lower-rated companies are also taking advantage of the fact that the bond markets offer them a way to avoid the onerous financial performance covenants that are often tied to bank loans, a big bonus in the current environment. Between January and April, high yield issuance represented less than 1% of the total monthly €-denominated non-financial bond issuance. But this number has been gradually increasing. Indeed, so far in October, high-yield companies have comprised 23% of total €-denominated non-financial issuance, a far higher proportion than in any previous month so far this year (see chart below). And investor demand for high yield issues has been strong. In mid-October, HeidelbergCement, a highly leveraged B1/B+ rated company, issued a record €2.5bn deal. Not only was the deal size increased from an original €1bn, the multi-tranche deal priced at the tight end of guidance on strong demand.
Chart 2: Investment grade and high yield €-denominated bond issuance
Source: Dealogic. October’s data is from 1st-22nd of the month.
But while many saw the deal from HeidelbergCement as an important step towards rebuilding the high yield market, we would highlight that it is still early days in the recovery of this market. Unlike the investment grade primary market whose strength now seems assured, the next few months will be crucial to establish whether initial investor bullishness towards high yield issues is sustainable and whether the nascent recovery in this market is here to stay. This is particularly true for weakly positioned issuers whose recovery remains uncertain, especially given that default rates are likely to peak toward the end of 2009/early 2010. And with corporate credit spread tightening likely to ease over the coming months, investors may also become more wary of investing in an asset class whose yields no longer offer such stellar returns.
Nicola Sanders, Credit Research
Disclaimer:
This research report is produced by Daiwa Securities Capital Markets Co., Ltd and/or its affiliates and is distributed by Daiwa Capital Markets Europe Limited in the European Union, Iceland, Liechtenstein, Norway and Switzerland. Daiwa Capital Markets Europe Limited is authorised and regulated by The Financial Services Authority and is a member of the London Stock Exchange, Chi-X, Eurex and NYSE Liffe. Daiwa Capital Markets Europe Limited and its affiliates may, from time to time, to the extent permitted by law, participate or invest in other financing transactions with the issuers of the securities referred to herein (the “Securities”), perform services for or solicit business from such issuers, and/or have a position or effect transactions in the Securities or options thereof and/or may have acted as an underwriter during the past twelve months for the issuer of such securities. In addition, employees of Daiwa Capital Markets Europe Limited and its affiliates may have positions and effect transactions in such securities or options and may serve as Directors of such issuers. Daiwa Capital Markets Europe Limited may, to the extent permitted by applicable UK law and other applicable law or regulation, effect transactions in the Securities before this material is published to recipients.
This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FSA and should not therefore be distributed to such Retail Clients in the United Kingdom. Should you enter into investment business with Daiwa Capital Markets Europe’s affiliates outside the United Kingdom, we are obliged to advise that the protection afforded by the United Kingdom regulatory system may not apply; in particular, the benefits of the Financial Services Compensation Scheme may not be available.
Daiwa Capital Markets Europe Limited has in place organisational arrangements for the prevention and avoidance of conflicts of interest. Our conflict management policy is available at http://www.uk.daiwacm.com/about-us/corporate-governance-and-regulatory. Regulatory disclosures of investment banking relationships are available at http://www.daiwausa.com/.
For more details, please contact:
Nicola Sanders, Credit Research
Daiwa Capital Markets Europe Limited
5 King William Street, London, EC4N 7AX
+44 (0)20 7597 8329
For up to date Research analysis, see our blog site here.