Uptick in high yield could signal start of recovery

High yield bond issuance made gains in some key jurisdictions in 2023 but challenges remain

High yield bond issuance in the US and Europe improved in 2023, but came in significantly below long-term annual averages, while markets in the Asia-Pacific (“APAC”) (excl. Japan) region remained stymied, primarily due to real estate liquidity headwinds.

In the US, high yield bond issuance climbed by 58.4% from US$96.5 billion in 2022 to US$152.9 billion in 2023. In Western and Southern Europe, issuance rose by 47.3% from US$53.9 billion in 2022 to US$79.4 billion in 2023.

In both jurisdictions, however, the large percentage increases year-on-year were bolstered by a weak market in 2022. According to Debtwire, 2022 represented the weakest year for high yield issuance in both the US and Europe in a decade. Although 2023 remained a relatively weak year when compared to 10-year averages, quarterly issuance in 2023 showed signs of stability, with quarterly volume in both the US and Europe exceeding volumes in each quarter of 2022 other than the first quarter, a period that benefited, in part, from the hold over from an exceptionally busy 2021.

Meanwhile, in the APAC (excl. Japan) region, issuance fell by 64.8% year-on-year from US$23.4 billion in 2022 to US$8.2 billion in 2023. Ongoing disruption in China’s real estate market, historically the single biggest driver of regional high yield issuance, continued to affect the activity level in the region.

High costs created a challenging market for issuance

Elevated interest rates continued to weigh on issuance in the US and Europe in 2023, discouraging issuers from tapping high yield markets if they could wait for more favorable market conditions. According to Debtwire, the European market saw average yields in the fourth quarter of 2023 climb to almost 9%, while in the US, yield climbed as high as 9.6% in October 2023.

Although fixed-rate high yield bonds offered borrowers certainty on financing costs when central banks began their cycle of interest rate hikes in 2022, rates generally climbed to levels where many issuers presumably chose either to hold off issuing into the high yield market or sought alternative financing sources that could be refinanced when conditions improved in the high yield market.

As central banks signaled that interest rate increases were peaking, and that rate cuts in the US and Europe could be in the cards in 2024, possible issuers have been waiting in the hope that benchmark interest rates will track lower in the months ahead and present more attractive conditions for high yield issuance. Indeed, green shoots are emerging and there is optimism that 2024 will be a better year for US and European high yield activity. At the end of 2023, yields also started to move lower, with average yields in the US and Europe edging down to 8.5% and 6.5% at year’s end, respectively.

In response to these conditions, some issuers have placed floating rate bonds that will see financing costs come down if base rates are cut in 2024. In Europe, for example, Debtwire figures show that a fifth of the bonds issued in 2023 carried variable coupons, up from an average of around 10% in earlier years.

Real estate is the key for APAC

By contrast, the outlook for high yield issuance in the APAC (excl. Japan) region in 2024 is less clear. Investors and lenders are continuing to assess the fallout from a liquidity squeeze in the crucial Chinese real estate space—a bellwether for overall APAC (excl. Japan) high yield activity, in addition to the impact of potential interest rate movements on borrowing costs.

Several high-profile Chinese real estate developers have either defaulted on bonds or missed interest rate payments over the last 12-24 months and investors have been nervous to support new issuance.

Concerns about real estate indebtedness and recovery prospects remain top of mind, illustrated by the hardships recently faced by Evergrande, a major real estate developer in the market. As attempts to restructure large Chinese real estate issuers turn into prolonged processes which, in certain cases, have ended in liquidation, investor caution remains high.

The headwinds facing the Chinese real estate sector are expected to continue to weigh on high yield issuance in 2024 in the region, but those challenges could be counter-balanced by rising refinancing activity. Asset manager Invesco anticipates that a growing number of issuers with short-dated high yield bonds will have to manage maturities during the next 12 months, which could spur an uptick in refinancings and exchange offers.

At a time when there is disruption in Asian high yield bond markets, new sources of capital are emerging to present borrowers with financing alternatives.

Private credit, which is still relatively nascent in APAC (excl. Japan), is expected to emerge as an increasingly important pool of capital for APAC (excl. Japan) borrowers. According to HSBC analysis of Preqin figures, Asia-focused private debt assets under management have grown at an annual average of almost 30% during the past five years and an increasing number of global private debt managers have expanded their operations in the region to take advantage of the growth potential.

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