Inverted Debt Markets Are Driving Companies To Play

Since bond yields have risen sharply over the past month, European companies are not being prevented from selling new debt in the same way they were prevented from selling new debt last year as a result of higher borrowing costs. Rather, borrowers are adapting their issuance to take advantage of an inverse government curve, where the yields are lower at longer maturities compared to shorter-dated debts, allowing them to gain a competitive advantage. While they are able to retain investor interest by paying to play, they are increasingly having to pay to play. Clearly, issuers and buyers are both adapting to the changing interest-rate environment in a flexible way in order to meet their needs.

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There has been an increase in longer-dated corporate bond deals this year. It is typical for borrowers to have to offer higher interest rates in order to borrow for an extended period of time. The recent spike in interest rates, however, necessitates a different type of incentive, which is a wider concession in the yield premium offered over the issuer's existing debt in the new issue. Long-dated deals have a relatively lower underlying yield, so investors are not quite being compensated for this fact by the increased spreads. However, there is enough demand to generate a healthy order book and find buyers when you are able to find them.

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It was a very stop-and-start year with 50 days of zero issuance last year, far higher than previous years - the next highest was 31 blank days in 2018. It has been a more robust year with just a few days of no new deals being recorded this year. There were 68 billion euros worth of euro investment-grade corporate bond issuance in the first two months of this year, an increase of 89% compared with the 36 billion euros issued by companies in the same period of 2022, according to Trade Algo.

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Even though financial firms' issuance increased by 47% or sovereign debt issuance rose by 24%, these sectors typically dominate volumes at the beginning of each year due to their relatively stronger credit profile and greater funding demands. However, this growth was significantly stronger than the 47% increase in issuance by financial firms. To date, the total volume of investment-grade bonds has reached 470 billion euros, which is 38% higher than in the same period last year. A rise in expectations for interest rates at the European Central Bank does not seem to be scaring investors away from high-quality debt.

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With super-low interest rates and tight credit spreads during the pandemic stimulus period, savvy corporate treasurers raised lots of cheap capital for many asset classes. The situation was even worse for investment-grade corporate debt, with yield-starved buyers loading up on anything and everything offering a pick-up over sub-zero government debt, especially when it came to investments. Several top-quality companies, such as Nestle SA, were even able to borrow at a negative yield and get paid in exchange for doing so.

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Many firms were able to sit out much of 2022 as issuing new debt became much more expensive as rates rose. The new normal of much higher yields has now become a well-entrenched phenomenon as central banks are steadily retreating from being the biggest bond buyers in the room to becoming net sellers as the bond market has slowed.

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There was no way that the hiatus could last forever, and this year corporates are extending the maturity profiles of their debts, paying relatively less for longer-dated debt because of those inverted yield curves and avoiding future debt repayment bumps. Since the end of 2022, the average maturity of Eurobonds issued by companies this year has increased from seven years to nine years. In the post-issue secondary market, deals are doing well this year, with an average credit spread contraction of more than 20 basis points in the year to date.

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Although underlying interest rate conditions have been shifting over the past few months - it was the worst February for bonds since its start in 1990, following its best-ever January - new issue concessions have increased, even for household names - as underlying interest rates have been shifting this year. In a three-tranche euro-denominated BASF SE deal that closed on the last day of February, the company offered up to 46 basis points more than its debt. In its 12-year euro deal, McDonald's Corp. had to offer a 32 basis-point incentive. The nine-year bond from AstraZeneca plc, which is worth €750 million, was issued at a 33 basis-point premium to its curve on Feb. 24.

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The sharply higher interest rates by the central banks, as well as the prospect of more to come, have definitely thrown the financial system for a loop. It can be difficult to keep fixed-income syndicate desks quiet for a long time, but it is impossible. Investor demand still exists - albeit at a price - if corporates are willing to bend to the changing winds and extend the length of their debt profiles.