US corporates have issued record-breaking amounts of debt in recent months to help weather the financial impact of the coronavirus pandemic, but investors remain largely upbeat on the long-term outlook for credit quality as the market heads into what is expected to be a bleak second-quarter earnings season.
Investment-grade companies have taken on a record-setting US$1.22trn of debt in the first half of this year, but credit analysts and bankers believe borrowers have a sufficient number of levers to pull to begin paying it off next year.
For example, companies are putting off acquisitions and cutting buyback programmes in a sign they will use the cash for debt reduction, according to asset management firm Columbia Threadneedle's analysis of 170 US-based companies.
The firm estimates that group of companies will spend US$180bn on buyback programmes this year, down from expectations of US$270bn at the start of the year. Additionally, those companies are expected to raise just US$100bn for acquisitions down from earlier estimates of US$250bn.
Buyback, dividend and acquisition spending all have room to be cut further, which would add to a US$1trn cash stockpile and US$600bn in available credit lines among such companies.
"It's not like these companies borrowed all this money and it disappeared; most of it is just sitting in cash," said Tom Murphy, Columbia Threadneedle's head of investment grade credit.
"Some of it will be used for higher operating costs and personal protective equipment, but it's there to be paid back when management teams and everyone feels better about the Covid-19 situation."
Additionally, about one third of issuance in the year to-date was driven by a need to address upcoming maturities in late 2020 or into 2021, said Meghan Graper, head of US investment grade syndicate at Barclays.
Some issuers are tendering debt early, some are just keeping cash on hand to pay off bonds at maturity, and others are terming out their commercial paper borrowings, she said.
"The short-dated nature of commercial paper means you are in constant refinancing mode, so terming out to long-dated bond maturities has proven to be an effective strategy to mitigate that more imminent funding need," Graper said.
In the high-yield market, there are bigger pockets of concern in certain sectors such as the energy and leisure industries.
But a similar wave of new debt issuance – US$224.4bn in the year to-date, a 68% increase on the same period last year, according to IFR data – has been broadly met with positivity by most investors.
"Right now, we view it as prudent liquidity enhancement," said Adam Spielman, head of leveraged credit at PPM America. "I think the borrowers are doing the right thing and we're comfortable funding some of that. But it has to be a business model that we think can operate with that higher debt load through 2021."
Like their investment-grade counterparts, junk borrowers are also seen to be using new bond issuance to pay down near-term debt maturities and put some cash on the balance sheet.
"The market is not accepting pure leveraging events such as holdco dividend deals," said Leland Hart, co-CIO at asset manager Alcentra.
The big uncertainty is how consumer habits may change as economies emerge from lockdown measures and what impact this will have on company revenues across different sectors – and ultimately their ability to service their debt loads.
Lodging, hospitality, leisure and gaming companies are broadly seen as the most vulnerable to changes in consumer habits.
Receptive capital markets have helped many of these companies bridge liquidity needs for the next 12–18 months – but with high-cost debt.
And if consumer behaviour is changed for the long term – less eating out, fewer flights, and fewer cruises, for example – investors expect debt restructurings and defaults to climb.
Fitch said in a June 30 report that while recent debt issuance in these sectors has helped stave off near-term bankruptcies, it could take some sub-sectors two to three years for credit metrics to return to 2019 levels.
"Some capital structures won't work," said Parmi Chadha, high-yield portfolio manager at Newton Investment Management. "If you're a high-yield corporate and four to five times levered, and you have a 10%–15% drop in your top line – if that drop is permanent, then your current capital structure is not sustainable."
High-yield investor portfolios are certain to be impacted by rising default rates, which have increased from 3.1% in May 2019 to 6.4% in May 2020, according to Moody's.
The rating agency said default rates could climb to 11.9% by the fourth quarter of this year.
But the huge refinancing efforts undertaken by borrowers in recent months may limit defaults to those that were already in trouble before Covid-19 took hold – such as struggling exploration and production companies in the oil and gas sector.
Just US$71bn of high-yield bonds mature in 2021, around 5% of the nearly US$1.4trn market, said Eric Rosenthal, senior director of leveraged finance at Fitch.
Of that, only US$12bn are rated Triple C, which are the most likely to default.
Fitch has a less pessimistic view of defaults in 2020, expecting a default rate of around 5%–6% by the end of the year, rising to 7%–8% in 2021.
"The reality is that only a very small portion of the high-yield and leveraged loan markets is coming due next year," he said. "It is not an end of the world scenario just yet."