As curtains were poised to close on U.S. high-yield bond issuance for 2017, volume was on track to total $276 billion, the most in three years, and 21% higher than the $229 billion printed in 2016, according to LCD.
While the 2017 volume fell short of the blockbuster annual totals of $310–345 billion from 2012 through 2014, the lion’s share of Street predictions suggest another year-to-year increase in volume ahead, albeit under wide-ranging projections for defaults and returns, and considerable uncertainty regarding how emerging tax policy will impact the most highly leveraged entities and select sectors.
Predictions on the Street for issuance in the year ahead range from flat on the bearish side, to a roughly $30 billion uptick in new paper on the bullish end.
J.P. Morgan is perhaps the most optimistic of them all.
“Capital market conditions for high-yield issuers are expected to remain robust,” the team, led by Peter Acciavatti, notes in its year-ahead outlook. “For 2018 we forecast high-yield bond and institutional loan new-issuance of $315 billion and $650 billion, respectively, or a combined $965 billion…. For net high-yield bond issuance, we expect an uptick in M&A volumes and a reduced emphasis on refinancing will translate into a $30 billion [year-over-year] increase in full-year net high-yield issuance to $150 billion.”
Morgan Stanley foresees high-yield bond issuance at $290 billion, not too far off from Citi’s expectations of $300 billion, with one potential source stemming from a burst of formerly investment-grade borrowers establishing funding positions under fallen-angel ratings profiles.
Meanwhile, Wells Fargo analysts have their sights set on a 15% year-over-year increase in volume, to conclude 2018 at $305 million.
BAML’s Oleg Melentyev, head of High Yield and Leveraged Loan Strategy, pegged developed markets’ USD supply at $270 billion next year, or up roughly 5 percent year-over-year, according to the bank’s 2018 outlook. However, that projection incorporated the risk of delayed or scaled-down tax reform.
Leading into 2017, the spotlight was on how the financial markets would adjust to President Donald Trump’s aggressive and business-friendly ambitions for his first year in office. But legislative inertia for much of the year gave way to tax-reform scenarios complicating the 2018 outlooks, alongside broad uncertainty regarding global Central Bank policy.
“I think one of the thoughts we’ve had is someone must have swiped our crystal balls and replaced them with snow globes because it’s harder to see as far out as we’d like,” says Ken Monaghan, co-head of high yield at Amundi Pioneer. “Headwinds will revolve around central bank policy. We’re wondering when that shifts. In tandem with that is the recognition that investor behavior could shift with the change in Central Bank activity.”
And when considering the influx of cash into the U.S. market from European and Asian investors, as well as a shift in Europe away from investment-grade rated paper into speculative-grade debt, Monaghan notes that there will be “a lot of competition for those assets.”
Proposals surrounding tax reforms, particularly the proposed limits on interest-expense deductibility, could be another wildcard for the market. The consensus is that borrowers who are highly-levered and further down in the credit ratings spectrum may bear the brunt of any negative effects.
“We need to break apart different segments of high-yield,” says Scott Roberts, head of high-yield for Invesco. “If the tax proposal does become law, the major impact could be on highly levered triple-C companies, and possibly on double-B levels. Some of the triple-C segments may see free cash flow pinched by this, but there isn’t any reason for any alarm bells—the aim of these proposals is not to see increased bankruptcies.”
“Net-net, I think there will still be a high-yield market around and people will still issue debt,” notes Loomis Sayles Eagan. “Most important takeaway is it’s likely to lead to more volatility through the cycle for leveraged credits. As profitability contracts throughout the recession, your deductibility will decrease.”
Another blip on the radar for many analysts is the uptick in PIK-toggle issuance late in the year, and the potential for the structure to be employed more broadly in 2018. For context, domestic PIK toggle issuance totaled $2.4 billion during 2017, nearly unchanged from the $2.6 billion recorded one year prior, according to LCD. However, these figures are still relatively low to double digit volume seen in 2013 ($11.6 billion), 2008 ($12.5 billion) or 2007 ($15.7 billion). Marty Fridson recently noted that some firms track issuance of the relatively esoteric instruments as a potential early-warning signal of excesses bubbling up in the marketplace.
Also, floating-rate notes (FRNs), a structure utilized more in the European high-yield market, could also see a larger presence in the U.S. next year. During 2017, the U.S. saw one lone issuer, Consolidated Energy, issue FRNs, for a year-end total of $300 million, to fall short of 2016’s $1.52 billion of printed FRNs, split via Ardagh Packaging and Reynolds Group. All three of the aforementioned issuers are not domiciled in the U.S. On average, FRN issuance totaled just $2 billion in each year between 2011 and 2016, and the peak was in 2006, $17.6 billion.
“It’s been a long time since we’ve seen any floating-rate notes (FRNs) issued,” says Amundi Pioneer’s Monaghan. “If we are in an environment where the Fed is more aggressive in raising rates, we could see a return to FRN issuance.
After the quarter-point Fed rate hike this month, S&P Global’s baseline projection is for three equivalent boosts in 2018, alongside the unwinding of prior quantitative easing. “Our base-case assumption is for a benign increase in borrowing costs that corporate borrowers will generally be able to adapt to, but rising financing costs may weigh on sectors that rely heavily on capital markets or are affected by the ups and downs of the housing market. As benchmark interest rates return to more normal levels and lenders regain stronger footing, funding liquidity could also become scarcer—and lower-rated borrowers could find it harder to issue new debt,” the agency says. — Jakema Lewis
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