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Fed keeps corporate bond market purring after COVID-19 drove record issuance

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Fed keeps corporate bond market purring after COVID-19 drove record issuance

Just because an end is in sight for the coronavirus pandemic, it does not mean U.S. companies will stop tapping the bond market.

One of the consequences of COVID-19 was a sharp ramping up of corporate debt issuance as companies raced to bolster liquidity in the face of plunging revenues. But even as the economic recovery from lockdowns gathered pace and liquidity became less of a concern, companies have continued issuing bonds, taking advantage of lower borrowing costs to refinance debt and extend maturities.

"Refinancing was chapter 1 of the COVID story, which gave way to chapter 2, which is now the favorable conditions and getting ahead of the debt," said Nick Kraemer, head of ratings performance analytics at S&P Global Ratings.

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The dash for cash started in March. Having first drawn down on credit lines as financial markets began to seize, businesses then flooded into the bond market to pay back their obligations with longer-dated debt. The guarantee of support by the Fed smoothed out credit markets and yields fell back, encouraging companies to refinance at lower rates.

By mid-August, investment-grade bond issuance had already surpassed the previous annual record of $1.221 trillion in 2017, according to data from LCD. As of the end of November, the 2020 total stood at $1.652 trillion.

With the economic recovery under way and the prospect of mass immunization against the coronavirus, U.S. companies might not need to tap bond markets at the same rate in 2021 as they did in 2020, but the prospect of accelerating economic growth and supportive monetary policy help support issuance.

"We expect a decrease in gross issuance volumes for the year 2021 as companies focus on reducing their level of debt," strategists Valentine Ainouz and Mickael Bellaïche at Amundi Asset Management wrote in their 2021 outlook. "However, the improving macroeconomic environment, easing financing terms, and high M&A expectations will likely offset some of this supply loss, especially in the U.S."

S&P Global Ratings note that typically bond issuance correlates closely with the economy, rising in periods of growth and falling as activity slows.

"We know that historically issuance is correlated with GDP at almost 1:1. GDP dipped to its greatest extent in the second quarter and yet we saw completely the opposite for issuance. We will start thinking, "alright, that relationship has broken down, when is that relationship going to come back into sync?" And that is an open question," Kraemer said.

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Monthly issuance peaked at $276.28 billion in April, the second in a sequence of three consecutive months where the volume topped $200 billion. Before March, the monthly record was $170.65 billion in January 2017.

As the economy recovered and the prospects of mass defaults eased, the pace of issuance slowed. A total of $158.75 billion in the last two months represents the weakest October-November period since 2013, though the total is just 2.5% lower than in 2019. But a supportive Fed and the low cost of borrowing means it is unlikely companies will stop the issuance binge completely.

Lower borrowing costs

The most obvious supporting factor for issuing new debt is the lower cost of borrowing. The S&P U.S. Investment Grade Corporate Bond Index yield-to-worst was 1.74% as of Dec. 1, down from 4.23% in late March. While the current yield represents a higher cost of borrowing for companies than in the eurozone, Japan, U.K., Australia and Canada, it is down markedly from the start of the year when the yield was 2.78%.

The market has been supported by loose monetary policy and that looks set to remain the case even after the U.S. Treasury decided to let some of the Fed's emergency lending programs expire.

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"The ideal conditions to issue are still there but you have to weigh that against how much volume has already come up," Kraemer said, noting that the case for supporting credit markets and encouraging high issuance has evolved from Fed support to the prospects of a vaccine. "Have the favorable conditions been put in place by those Federal Reserve facilities? And has the baton been handed off from the Fed facilities to the vaccine development?"

The yield premium on corporate debt over Treasurys continued to narrow even after U.S. Treasury Secretary Steven Mnuchin vetoed a prolongation of the Fed's corporate credit facility and main street lending program. The two policies, designed for the emergency response to the pandemic, signaled the extent of the Fed's desire to support business, though in the end were little used.

"All in all, it can actually be seen as positive/dovish news that Mnuchin vetoed against a prolongation of the crisis measures as the Fed is now more inclined to turn more dovish on instruments that are actually put to use," Andreas Steno Larsen, global chief FX & rates strategist at Nordea, wrote in a research note, suggesting the Fed may increase the duration of its ongoing asset purchase program.

With cheaper borrowing has come longer-dated debt. The average maturity of U.S. investment-grade bonds has lengthened to 12.8 years from 11.5 years at the start of 2020, according to S&P Global Ratings, as companies push back the debt wall.

"Lengthening maturity and getting lower rates; there's a lot of common sense stuff going on in terms of taking advantage of the market right now," Kraemer said.

LCD is an offering of S&P Global Market Intelligence.