High yield bond markets in the United States and Western and Southern Europe remained open for business in Q3 2020, as government and central bank stimulus funds, coupled with borrower appetite for cash to bolster COVID-19-affected balance sheets, sustained activity levels.
High yield bond issuance in the US eased from US$150.9 billion across 198 deals in Q2 2020 to US$116.5 billion across 158 deals in Q3, but these two quarters are still the highest on record since 2015—both in value and volume.
Year-on-year issuance in the country climbed 92% from US$177 billion over the first nine months of 2019 to US$340.5 billion for the same period this year.
In Western and Southern Europe, meanwhile, issuance for the first three-quarters of 2020 was also up on the previous year, rising from US$72.9 billion for the year through Q3 2019 to US$78.1 billion over the same period in 2020. European issuance did not spike in the second quarter as it did in the US, but has followed a steady upward curve post-lockdowns.
Stimulus keeps markets moving
Government stimulus packages and central bank measures to prop up economies after the COVID-19 market dislocation in March offered crucial support for high yield bond markets on both sides of the Atlantic.
In the US, the Federal Reserve’s program to invest in high yield exchange traded funds (ETFs) and buy fallen angel bonds injected much needed liquidity into the market, encouraging bondholders to invest additional capital. The Federal Reserve also extended the program, known as the Secondary Market Corporate Credit Facility, to the end of the year.
The European Central Bank (ECB), meanwhile, extended its Pandemic Emergency Purchase Program (PEPP) to €1.35 trillion in June. Although PEPP only extends to investment grade and government bonds, fallen angel credits can be offered as collateral for the lending and the ECB has not ruled out future high yield investment.
Low interest rates have provided further support for issuance. The Federal Reserve is using average inflation targeting when setting interest rates, and will only wait until inflation moves above 2% before moving to increase rates. The ECB main interest rate is at a record low of 0% and analysts believe negative rates are still a possibility. Against this backdrop, high yield bonds have offered investors more attractive yields relative to syndicated loans, which are set in line with floating interest rates.
Borrowers take advantage
Initially, the vast sums of stimulus cash poured into economies encouraged companies hit by steep revenue declines to issue high yield bonds and shore up cash reserves.
Since then, as equity markets stabilized and there have been signs of economic recovery, issuers have also started to look for windows to refinance existing debt on better terms and to extend maturities.
In the US, the combination of low interest rates and investor appetite for yield has pushed the market back in favor of borrowers. According to Barclays, almost two-thirds (65%) of high yield bonds issued since July have had coupons of less than 6%. Aluminum can manufacturer Ball Corporation secured the lowest-ever interest rate for a non-investment grade US company when it raised a ten-year US$1.3 billion high yield bond with an annual coupon of 2.875%.
The European market has also seen borrowers secure financing at attractive rates. Water dispensing business Primo Water, for example, raised a €450 million bond with a rate of 3.875% in the European high yield markets in October. Primo will use this issuance to refinance notes issued earlier in the year, and priced at 5.5%, to fund its acquisition by Cott.
German specialty pharmaceuticals business Cheplapharm, meanwhile, issued €575 million of notes at 4.375% to fund the purchase of four portfolios of pharmaceuticals products.
The future remains uncertain
As the market moves into the fourth quarter, high yield issuers face a rocky period. Even though bond buying programs remain in place, there are some indications that central banks are taking the foot off the gas when it comes to deploying cash into high yield bond investments. For example, Citigroup’s analysis of the Federal Reserve’s bond buying program shows a material slowdown in the volume of capital the Fed is investing in high yield assets.
Looming uncertainty around the US presidential election and a second wave of COVID-19 across Europe have also shifted investor risk appetites. Demand for yield is still strong, which will encourage high yield issuers, but investors are more concerned about risk, which could see capital flow back to more secure investment grade and government bonds.
Moody’s and S&P, for example, predict default rates of 12% or more next year for non-investment grade corporate issuers. In September, high yield bond funds saw their largest outflows since the spring lockdowns. High yield bond ETFs have already seen the gains made earlier in the year evaporate.
It will also be interesting to see whether robust issuance in the second and third quarters continues now that companies have addressed their liquidity needs and M&A and LBOs have yet to return to pre-COVID-19 levels.
After a strong response to the volatility imposed by COVID-19 in the first half of the year, high yield markets are bracing for an uncertain close to 2020.