After enduring a steep and sudden decline at the end of Q1 that effectively shut down high yield bond markets in the US and Europe, the high yield markets have shown signs of life since the beginning of April.
Issuers in the US managed to tap high yield markets for much needed funding, raising US$21 billion during the first three weeks of April. Highlights included a US$8 billion issue for Ford Motor Company and a flurry of new offer announcements. The spike in activity levels has seen overall US issuances roar back in April, with initial figures for the month of approximately US$38 billion of issuances. For the week commencing April 13 alone, issuances came in at US$18.75 billion according to Debtwire Par, almost four times more than the US$5 billion recorded for the entire month of March.
In Europe, the recovery was more muted, but alarms system company Verisure did reopen the high yield market in March after a month of no issuances, with a successful €200 million (US$217 million) issue.
These green shoots are welcome after a difficult end to Q1, when the COVID-19 virus took a profound toll on US and European high yield bond issuances. Although headline Q1 2020 figures compared favorably with a year ago, a steep drop in March froze markets on both sides of the Atlantic.
The US, for example, recorded US$71.4 billion of issuances in the first quarter of the year, up 25.9% on Q1 2019 numbers, but this was almost entirely due to the strength of the market going into the year, according to Debtwire Par. Once the spread of COVID-19 began to accelerate, issuances plummeted to just U$4.7 billion in March, following two consecutive months of US$30 billion-plus issuances in January and February.
The fall was even more pronounced in Europe. The first quarter showed improvement on the same period in 2019––up 71% to €20.8 billion (US$23 billion)––but the market completely shut down in March with zero issuances. The freeze followed a promising start to 2020, which included a €2.8 billion (US$3.1 billion) bond issued by Altice Financing, the third-largest first quarter issue in the past five years. After TalkTalk’s £575 million (US$718 million) offering the day before Valentine’s Day, no more deals involving European issuers priced in Q1.
The US market managed to continue functioning through Q1, but at significantly reduced levels and higher costs for issuers. Fast food chain Yum Brands, for example, was the first US Q1 high yield bond to price since March 4. Yum secured a US$600 million unsecured note on the last day of March, but the deal came at a substantially higher price. Yum’s offering priced at an interest rate of 7.75%, approximately double the cost of the group’s longer dated notes.
Other companies tapped the market after Yum, and US issuances for Q2 will be lifted thanks to successful issues by Carnival (which abandoned attempts to raise finance in Europe), TransDigm, Tenet Healthcare and Restaurant Brands early in April. More expensive finance, however, is the new normal. Carnival, for example, will pay a yield of 11.5% on US$4 billion of bonds maturing in 2023. Last October, the same business was able to borrow €600 million (US$652 million) in Europe at a yield of 1%. Average weighted yield to maturity reached 7.57% for issuances in April compared to the 5.16% averaged recorded in Q1, according to Debtwire Par.
Investors start to scatter
Economic shutdowns around the world, which have forced some businesses to stop trading and curtailed consumer and business spending, saw increasingly risk-averse investors pivot out of high yield bonds into less volatile assets.
In Europe, the value of high yield bonds dropped 13.2% in March, while US high yield bonds shed up to 21% during Q1, before stabilizing at 13%, according Debtwire Par. US high yield bond funds endured five weeks of outflows totaling US$10.9 billion through the end of March, although stabilizing bond and equity markets helped reverse the trend and attract capital back into the asset class.
Outlook
While some stability returned to the high yield bond market in April (including increased activity at the end of the month), and issuers found investors willing to lend (albeit at significantly higher prices), uncertainty remains high and the impact of COVID-19 on economies will continue to reverberate for the foreseeable future.
Investors in the US will also note that ratings agency Fitch raised its forecast for defaults in 2020 from 3.5% to between 5% and 6%. Downgrades and defaults are expected to increase in the short to medium term as borrower earnings continue to feel the squeeze.
The long-term consequences of COVID-19 on high yield issuances and default rates, however, may only be felt many months down the line once grace periods have run out and the full impact on company earnings becomes clear.
Investors and issuers, however, will take comfort from the gradual lifting of lockdowns in some countries, a degree of stability in stock markets and the appetite from investors for higher quality credits. The US Federal Reserve’s announcement that it will purchase high yield bond ETFs (exchange traded funds) and the European Central Bank’s confirmation that it will still buy bonds issued by borrowers downgraded from investment grade provide further reasons to hope the early Q2 rally can continue to build.