"Massively Compromised" - Corporate Debt Issuance Soars To Record Highs

Authored by Bill Blain via MorningPorridge.com,

“Is it possible a cur can lend three thousand ducats?”

Yesterday the US Primary Investment Grade Bond market touched a record $1.346 trillion issuance this year, surpassing the total for 2017, still with the three busiest months in the new issue market to come. The global volume of new corporate debt in the first half of 2020 exceeded $2.5 trillion. It’s a great year to be a new issue debt banker… 

The market volumes have been extraordinary. The rise in US issuance is in no small part due to the Fed’s unlimited liquidity via its investment grade QE programme. The Fed has barely had to buy any debt – the mere promise to do so has been enough. The ECB’s corporate QE Infinity programme has been equally stimulative.

Right across the investment banking multiverse, new issue desks are preparing themselves for an absolute torrent of new corporate debt to hit the markets when the new issue funding season reopens in September. Actually, it hardly closed for a break in August – the demand for high-grade paper to meet cash inflows into bond funds hasn’t abated!

Who would not want to own corporate debt? Central banks have promised to buy anything investment grade. There is no liquidity threat. Back in 2008, bond markets locked tight as it become impossible to sell paper. Bids evaporated in an offered only market. No problem this time – just call the Fed. 

But.. what about returns? 

Well its now an ultra-safe market.. so why worry about returns? (Yes.. you should worry about zero bond returns…) As demand for corporate debt has soared, so have prices, causing the average yield – the Bloomberg Barclays US Aggregate Corporate Index - to drop to 1.82% earlier this month. A record low yield. If you bought the index in March, you’ve made a very healthy return from when it stood at a distressed 4.5%. 

Supply has been fuelled by corporates scrabbling to finance themselves through a Pandemic lockdown of unknown duration. There has been a stampede towards the new issue funding desks. When I was a Debt Capital Markets banker we always told our clients: don’t fund when you have to.. fund when you can. This is a time when they can.. So they have, and they are still funding. 

Rising leverage is another consequence of QE Infinity. The Fed’s promise to provide liquidity means any investment grade corporate can access as much cash as it wants, and is free to spend it as it sees fit. Are the ratings agencies worried? Don’t know, and they don’t particularly seem to care.. but I ain’t reading many headlines about their rising concerns on debt levels. (What I did spot was these oh so clever rating agencies agreeing the EU borrowing €750 trillion to finance Virus recovery is not apparently a worry… Yeah.. Right?)

But, but and but again… Who wants to own corporate debt at sub 2%? 

If you think it’s going to tighten further – then perhaps, but 2% is not a real risk return. Any Risk vs Return calculation has been massively compromised by the absolute low risk-free rate – Treasury bonds. If government bonds yield close to nothing, then it makes anything positive relatively attractive – but still a negative real yield or close to it. If you really think a 100 basis point risk premium is a fair payment for taking corporate risk on a name one step away from junk in the face of this looming recession… then I have some bonds you really should buy. 

Ultra-low interest rates (ZIRP and NIRP) plus unlimited FED liquidity have fuelled the bond binge. Corporates are loving it – Apple recently issued a $8 bln “general corporate purposes” bond we all know will go to funding stock buybacks. I hope Tim Cook thanks the Fed. Apple is getting that money for practically nothing – the 40 year tranche paid 2.5%. (And I will refrain from idle speculation on whether we will still be buying Bright Shiny Things from Apple in 2060.) 

Over the past 10 years, US corporates have spent around $9.2 trillion buying back their stock – money that wasn’t spent on building new factories, infrastructure, products or creating jobs… but boosting the bonuses of executives and dividends to owners… 

My recollection is that $9.2 trillion pretty much equates to 80% of what they’ve borrowed over the past 10-years (sorry, but I don’t have access to a Bloomberg at home to actually dig out the numbers), which means the last 10-years of artificially low Interest Rates has not created a debt-driven boom in corporate investment, product innovation and expansion, but has basically all gone into the pockets of insiders and owners. 

(I should not complain. Apple is my largest PA stock position. But it doesn’t feel right.)

In April Boeing was able to tap the US investment grade market for $25 bln. That enabled it to avoid the embarrassment of going cap in hand to the US government for a bailout. It should see it through to the end of this year of slowed deliveries and making over 10% of its workforce redundant. Over the past 10 years Boeing has been textbook everything that’s rotten with Corporate America – if failed to develop new models, it compromised safety on its 737 Max (killing 346 passengers and crew) instead, and spent most of its profits and new debt on stock buybacks – leaving the company a fractured mess. It will survive – but only because of its criticality to the US economy (1% of GDP in good years) and it’s a massive defence contractor.

And how much of the corporate debt raised in investment grade and junk markets (which similarly benefit from Central Banking largesse via ETF purchases), is going to be Zombie companies with little chance of repaying that debt should condition deteriorate or interest rates rise? (Ie in both good and bad economic scenarios, most Zombies will… “perish”… ahem..)

Basically, the booming new issue bond market is sustained entirely on ZIRP, QE Infinity and the need for Debt Capital Markets Bankers to earn their bonuses by persuading corporates that open markets today means its time to “fill their boots” issuing new debt. The door is open today.. Tomorrow? Maybe not… 

(Or… if you are prepared to free yourself from the shackles of Central Bank liquidity – we have 4-5% yield secured assets, and double digit project finance deals to finance. Real Assets with real yields..)

Finally, might I refer you to my latest Lite-Bite video commentary I’ve done for Shard Capital.

This week I look at the strength of markets in the face of looming Pandemic recession, and propose a dual investment strategy of arbitraging the Central Banks, while building a “risk-off” investment bunker from Gold and Govt Bonds.