Thursday, 24 January 2019

Deal or no deal

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An M&A frenzy has propelled the US high-grade market to new highs in 2015. But a prolonged cycle of easy money for borrowers is drawing to a close

A burst of financing to support mergers and acquisitions has pushed US high-grade issuance to a fresh record but, since the summer, unbridled volatility has tested the dollar market’s famed resilience.

US investment-grade debt volumes increased 12.2% compared to the first nine months of 2014 and ranked as the largest first three quarters on record, according to Thomson Reuters data. The US$983.3bn raised from 729 issues surpassed the US$876.2bn during the same period of 2014, as issuers continued to take advantage of low interest rates.

All of the increase was accounted for by a surge in corporate investment-grade issuance, which jumped to $646bn from $492bn a year ago, powered by 13 jumbo deals, each worth more than $10bn, raising a total of US$170.6bn. Prior to this year, just eight offerings greater than US$10bn have come to market over the last decade.

But bankers fear issuers could pay the price for the conflicting signals sent by the Federal Reserve when it decided not to hike rates in September. The central bank agreed to keep rates on hold, citing global growth concerns, only for chairwoman Janet Yellen to say later that the Fed still hoped to raise rates in 2015.

Analysts at Bank of America Merrill Lynch said in a note to clients: “With the uncomfortable combination of global weakness and Fed rate-hiking risks, financial markets – including credit – sold off. The message from the markets to the Fed was clear – don’t hike in an environment of global weakness.”

With some economists predicting the US economy could fall into recession during 2016, there are concerns that the Fed might have missed its window and will not have anywhere to hide.

Year of two halves

This gloomy prognosis reinforces the view that 2015 has been a year of two halves for the US investment-grade market. During the first six months, event-driven financings hit an all-time high as the US M&A boom triggered a slew of massive bond market deals and borrowers tapped the markets at will.

In total, M&A financings and share buybacks accounted for of more than a third of corporate supply, and that event-driven burst masked a sharp drop in refinancing activity.

The US M&A boom has been driven by record levels of activity in the healthcare sector, which in turn has fed the bond markets. Healthcare-related M&A deals accounted for three of the top five US corporate dollar deals in 2015, led by Actavis, which came to the market on March 30 with a $21bn 10-part deal to help fund its $66bn purchase of Botox maker Allergan. Actavis enjoyed the best of market conditions as it attracted an order book of $100bn and printed the second biggest deal in US corporate history.

Other event-driven deals linked to share-buybacks and spin-offs were also in vogue, with Microsoft raising $10.7bn and Hewlett-Packard taking home $14.6bn to fund the spin-off of its enterprise division.

“Investors have shown a clear preference for large well-flagged liquid deals over smaller off-the-run trades,” said one head of syndicate at a US bank.

The financial sector was less active, with the flow of Yankee issuance dropping during the first quarter as the ECB’s quantitative easing removed the need to access the market.

The turning point came in the summer, when volatility in China exacerbated the usual seasonal lull and the high-grade market, so used to hitting new highs, posted a more ignominious milestone. Between August 21 and September 3, no issuers came to the market, breaking the previous record set in the wake of the Lehman Brothers crisis in October 2008.

But bankers are reluctant to draw too many comparisons and, in contrast to Europe, where markets can open and close, bankers argue that despite the summer hiatus, the US debt capital markets were never actually shut.

“In 2007, the music stopped; it’s not the same this time,” said Mark Bamford, global head of fixed income syndicate at Barclays in New York. “The market remains open; just at a higher premium to new issuers.”

Supply has not really recovered since. Borrowers still managed to print $90bn in September, led by a slew of issuance by banks and finance companies, but confidence is badly dented. Prospective issuers have been pulling bond issues, while those that had immediate financing needs were forced to tap the market at elevated new issue concessions. In September, Hewlett-Packard paid a new issue premium of around 40bp on several tranches of a nine-part $14.9bn trade, while Enbridge was forced to stump up 87.5bp of NIC, by far the highest of the year.

The question is whether this marks the end of a prolonged debt capital markets boom in the US. “We’re in the eighth year of a refinancing cycle, so the pipeline will inevitably slow,” said Bamford.

It is tempting to think that when the Federal Reserve raises rates at some point in the coming months it will signal the end of the high-grade party, but that would be to forget the market’s status as the world’s most liquid – and resilient.

Technical strength

The US market benefits from strong technical conditions that underpin its resilence. Pension and insurance funds continue to put cash to work in US credit, while high-grade benefits from a flight-to-quality allure when risk-aversion sets in. With a distinct lack of liquidity in the secondary sector, investors rely on the primary market.

Added to that, credit conditions remain relatively solid. “The credit markets function well in a backdrop of low rates and low inflation and slightly slower-than-expected economic growth,” said Bamford.

Nor should a rise in rates send issuers scampering for the hills. For all the talk of Fed ‘lift-off’, when tightening comes, it will likely amount to 25bp, which will ensure that the all-in cost of financing will remain near historic lows.

What is likely is that issuers will be forced to readjust to a market where they will have to pick their moment, navigating volatility then leaping through more limited windows of issuance.

Those windows could become increasingly tight. Investors dislike uncertainty, and until the Fed actually raises rates – however well telegraphed and small that is – the impact on the primary issuance market will not be known. A rate rise would be a bullish sign for the US and global economy which conversely would be negative for credit. Nor has the market faced its stiffest test – the impact of a credit sell-off in the new post-Dodd-Frank environment of depleted liquidity.

While the pace of refinancing continues to slow, the M&A arena is likely to continue to grease the wheels of the new issuance market. Bankers estimate that there are around $100bn of outstanding bridge loans related to M&A waiting to access the bond markets, and that does not include the US$70bn-plus package that brewing giant AB InBev is looking to put in place for its potential acquisition of SAB Miller.

Depending on how the blizzard of macro-uncertainty plays out – from potential full-blown conflict in the Middle East through the continued unraveling of commodities and further weakening of the Chinese economy – if the outlook for the M&A market remains robust, then 2016 could bring a surge in deal-making from European companies. And they will head to the mighty dollar market to meet their jumbo financing needs.

In the immediate future, high-grade issuance could be subdued for the rest of the year because the expected wave of event-driven financings related to transactions has not materialised. That is because the optimism of the earlier part of the year encouraged some syndicate bankers to think that issuers would be tempted to rush their financings to market before the Fed raises rates. However, a more sober view has prevailed in the light of recent events.

First, the bulk of the M&A financings relates to transactions not scheduled to complete until 2016 and, with the Fed still holding rates at record lows, there is no need to hurry. Second, regulatory uncertainty surrounding a number of big M&A transactions means issuers will have to wait before refinancing, while the cost to a company of carrying the proceeds of a jumbo refinancing on its balance sheet too far in advance of a deal completing is an added reason to hold off.

While the calendar builds to suggest a strong start for 2016, the intervening hiatus will be good for the US market . A lack of supply will boost the technical bid for high-grade paper and lead to spread-tightening.

Seasoned US DCM bankers say that Treasury market volatility is the biggest threat to the high-grade market.

“Financing conditions will remain attractive for a while yet,” said one US banker. “When the 10-year gets to 4%, well, that will be a time to worry.”

“Throughout the many bouts of market turmoil we have seen down the years, the US high-grade market has always proved to be the most resilient,” said Bamford.


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