As we near the half-way point of 2017, I thought it might be a useful time to have a brief conversation with our Head of Syndicate, Victor Forte, to discuss his thoughts on the corporate bond market so far this year and his outlook on issuance going forward.
For background, 2017 corporate bond issuance by investment grade companies has topped $651 billion year-to-date, which is slightly ahead of last year’s volume for the same time period. Despite this record pace of issuance volume by investment grade borrowers, the spread that these companies have been paying over the corresponding treasuries to issue debt remains at multi-year lows.
Moreover, the nuanced execution dynamics managed by syndicate professionals have been largely positive. Concessions to existing secondary bonds to price new issues are low (or negative in many cases), investor demand for these new issues is high - as measured by oversubscription rates - and investor demand is strong across the ratings and maturity spectrums.
Tom: As someone who spends time with both issuing and investing clients, what are some of the key observations and assessments you are making regarding the strength and resiliency of this current market?
Victor: I am frankly as impressed with what the market isn’t doing versus what the market is getting done. Take the Fed funds futures contract; the expectations for a Fed move in June has been nearly 100% since the French election finished in May. Despite the market expectation for a rate hike, corporate bond investors seem unconvinced that the economy is strong enough to cause inflation and correspondingly drive longer-term government bonds higher in yield. What is evident is that we are still living in an investment world where investors feel that term rates will remain lower for longer, and as a result, their allocation will remain high to spread products within fixed income versus entering into a rotation back to government bonds or equities.
Tom: One noticeable issuance trend has been the rise in floating rate note issuance. What do you think is driving this?
Victor: On the issuer side, many corporates have been overly fixed versus their target mix of debt, so the ability to source floating rate debt as part of an issuance is attractive from a risk management perspective. A number of the more significant floating rate transactions have been components of larger multi-tranche offerings often associated with M&A, where a floater in the bond market is competitive from a pricing perspective with bank debt. On the investor front, the rise in LIBOR has started to make break-evens between fixed and floating tranches look better for the investor. Obviously, floaters are “defensive” instruments, and with continued expectations of future rate rises by the Fed, investors feel they offer some protection to their portfolios.
Tom: There are still a number of geo-political headlines looming between Brexit, QE in the Eurozone, China and global political elections. What is your outlook for the summer and early fall?
Victor: It is very hard to predict what might derail the strength of the corporate bond markets. History has shown that during times of heightened geo-political risk, we see investors initially take some caution, which causes spreads to widen modestly and new issue concessions to increase. However, investors have generally come to the conclusion that investment grade corporate bonds are really a safe haven asset class, offering some incremental yield to the risk free rate during times of stress. What I worry about is whether we are winding up the coil in terms of the suppression of government bond yields and that, perhaps, the Fed may be correct in their optimistic outlook for the economy. No one is really expecting a rapid rise in term interest rates and even a quick or violent move toward 3% could cause a lot of pain for corporate bond investors.
Tom: As a syndicate manager, what do you see as the optimal number of bookrunners and what are some of the key questions issuers should ask their underwriters during an offering?
Victor: Great question. I am a big believer that issuers and syndicate managers need to stay flexible and nimble during executions. I joke that I sometimes feel like issuers have heard certain “conventions” about best practices and the “absolute” correct way to execute their deals that seem to come from a handbook for an “Intro to Syndications 101” course that I just don’t subscribe to. Each deal is different and the result of each action poses different decision trees during the process. Historically, the most often used number of active bookrunners is between three and four. I think that gives enough varying opinions to help ensure best practices and avoid what some dealers term as “too many cooks in the kitchen.” I’m actually more focused on the diversity of dealers and having banks whose approaches to the market vary and whose skill sets vary as well. A lot is also incumbent upon issuers, not just on their dealers, regardless of how many. In today’s environment, I think issuers need to aggressively push underwriters to defend the validity of the secondary trading levels used to establish relative value. For example, issuers should ask underwriters to test how liquid the bond is, explain how it has been traded, and make them account for recent trends in prices. I also think issuers shouldn’t ask for “consensus pricing” until very late in the process. It only encourages groupthink and least common denominator thinking regarding the correct pricing level for a new bond.
This document is NOT a research report under the legal requirements in any country or jurisdiction designed to promote the independence of investment research and is NOT a product of a fixed income research department. This document has been prepared for institutional clients, sophisticated investors and market professionals only, on the basis of publicly available information. This communication has been produced by and for the primary benefit of a syndicate desk. It is not investment research nor considered impartial in relation to the activities of this syndicate desk.