High yield bond activity in key global markets showed signs of life in Q1 2023, with quarter-on-quarter issuance improving despite ongoing macroeconomic challenges.
In the US, high yield bond issuance in Q1 2023 came in at US$29 billion, more than double the US$12.6 billion secured during the final three months of 2022. Western and Southern European markets also rallied, with issuance up by 65% quarter-on-quarter to US$15 billion, while, in Asia-Pacific (APAC, excl. Japan), high yield issuance improved from US$1.1 billion to US$2.1 billion during the same period.
Although year-on-year issuance across these three jurisdictions showed steep declines (the high yield market in the US was down 34% year-on-year, Western and Southern Europe were down 44% year-on-year and APAC (excl. Japan) was down 74% year-on-year), the uptick in quarterly activity after a tepid close to 2022 has given investors and borrowers some comfort. US and European high yield bond markets, in particular, are showing signs of momentum in 2023 as issuance exceeded the levels recorded in each of the previous three quarters.
Refinancing supports rebound
The uptick in activity during Q1 2023 was predominantly driven by refinancing, with weak M&A markets impacting the pipeline of M&A and leveraged buyout financing opportunities. Global M&A deal value dropped by 40% year-on-year in Q1 2023.
In the US, high yield bond issuance intended for refinancings soared from US$4.8 billion in Q4 2022 to US$22.4 billion in Q1 2023, with refinancing high yield bond activity in Western and Southern Europe climbing from US$1.4 billion to US$5.6 billion. In APAC (excl. Japan), high yield issuance intended for refinancing more than doubled from US$620 million to US$1.5 billion over the same period.
M&A and buyout issuance, by contrast, was muted, with no related high yield activity in APAC (excl. Japan) and quarter-on-quarter declines of 62% and 33%, respectively, in the US and Western and Southern Europe.
Refinancing was also buoyed by improving pricing dynamics from a company perspective, which encouraged issuers to come to the market and refinance existing bonds.
In Europe, the weighted average yield to maturity for high yield bonds came in at 9.4% and 6.5% for secured and unsecured notes in Q1 2023, down from 11.2% and 8.6%, respectively, in the previous quarter, according to Debtwire Par.
In the US, the picture was more mixed, with weighted average yields to maturity on senior secured notes easing from 8.59% in Q4 2022 to 8.02% in Q1 2023, although pricing on unsecured notes ticked higher from 7.91% to 8.56% during the same period.
Safety first
The dispersion between pricing for secured and unsecured bonds in the US market reflects a “safety first” approach from investors, who pivoted away from riskier assets in the face of a “mini” banking crisis in the US that saw Silicon Valley Bank and Signature Bank collapse, and JP Morgan acquire the assets of California-based regional bank First Republic in a rescue deal pulled together by banking regulators. This risk averse approach saw secured bond issuance account for more than two-thirds (67%) of overall high yield issuance in Q1 2023—the highest level since 2015, according to Debtwire Par.
With bond defaults in the US edging upwards to 1.8% for the past 12 months, to the end of March 2023, according to Fitch Ratings, investors are expected to continue favoring safer assets in the coming months.
This focus on risk mitigation has also been reflected in the relatively high uptick in floating rate bonds versus fixed rate bonds in Europe. According to Debtwire Par, floating rate bonds represented a fifth of European high yield issuance in Q1 2023, well above the 10% average for the past decade, as investors moved to ensure that the pricing on bond debt would benefit from any further interest rate hikes.
China real estate still weighs on APAC
Investor caution has also filtered into the APAC (excl. Japan) market, even though the challenges posed by banking stability and higher interest rates have been less pronounced than in Western markets.
Distress and high levels of indebtedness in China’s real estate sector—historically a key driver of dollar-denominated high yield bond issuance in Asia—continued to weigh on APAC (excl. Japan) high yield markets in Q1 2023.
Even though Chinese economic activity has benefitted from the lifting of COVID-19 restrictions and government support has helped improve the performance of Chinese high yield dollar bond indices (which are dominated by real estate companies) from the lows seen in November 2022, global investors are still wary of financing new China real estate bonds given the high levels of debt in the sector. From a borrower perspective, rising borrowing costs have also deterred many real estate borrowers from coming to market.
There were, however, signs of renewed investor engagement for the right names, as evidenced by property developer Dalian Wanda’s two dollar-bond sales in Q1 2023.
As the balance sheets of other developers such as Country Garden recover, it is hoped that momentum will build across the sector through the rest of the year, as the Financial Times reports.
Looking to the future
Even if China’s real estate sector fuels a wider regional high yield rebound, APAC (excl. Japan) high yield activity still has a way to go to recover to previous levels of activity. Markets in the US and Western and Southern Europe also have lots of ground to make up.
High interest rates and ongoing geopolitical uncertainty will continue to challenge markets, with soft M&A activity and rising defaults also a concern.
Investors and borrowers, however, have been navigating these challenges for more than a year now, hoping that the quarter-on-quarter improvement in activity levels observed in Q1 2023 is a sign of better things to come.