Can Demand Keep Pace With Record High Yield Supply?
It is no secret that this year has been a big one for corporate debt issuance in the US, as the pace of the economic recovery and the low interest rate environment make a number of different funding sources available to firms at attractive rates. However, after a soft September for risk markets and with tapering firmly on the horizon, this is perhaps a good time to consider whether investor appetite can continue to match the record issuance figures we have seen across 2020 and 2021.
US high yield issuance year-to-date stands $395bn, a 13% rise on the same period in 2020 and already on the verge of surpassing last year’s record annual total. Leveraged buyout (LBO) activity, a major contributor to high yield issuance, has also been increasing, with September one of the busiest months on record for high yield LBOs and Q3 the busiest quarter since the global financial crisis. With inflation also front of mind for market participants in 2021, it is loan financing (a largely floating rate product) that has skyrocketed in 2021; September was the second busiest month on record for loan issuance, with YTD volume up a staggering 147% year-on-year at $725bn. Investors’ appetite for floating rate product has also fueled a surge in collateralised loan obligations (CLOs).
Given the prospect of central bank tapering and ultimately interest rate rises are looming ever larger, it is no surprise dealmakers are trying to take advantage of attractive financing terms while they still exist. A good example of what can currently be achieved is healthcare supplies giant Medline Industries, which has been acquired by Blackstone, The Carlyle Group and Hellman & Friedman in a multi-tranche deal worth $33.7bn, the largest LBO transaction since the financial crisis. The financing package includes two syndicated loans (a $7.27bn Term Loan B and a $500m-equivalent Term Loan B in euros) and two bonds ($4.5bn in senior secured notes and $2.5bn in senior unsecured), in addition to a $1bn five-year cash flow revolver, a $2.2bn CMBS deal and $16.5bn in sponsor and Mills family rollover equity. Despite the scale the market had no trouble absorbing the supply, with the deal multiple times oversubscribed.
With transactions like this achievable, it is no surprise to see acquisition financing accounting for a growing proportion of high yield bond supply. While refinancing remains the primary source of new issuance and has led the monthly totals for 17 consecutive months now, some $16.5bn (or 38%) of September’s issuance was used for acquisitions, a three-year high. Over the course of Q3 acquisitions accounted for 27% of issuance, and year-to-date the share has been 18%, a big jump from 8% for the same period in 2020.
The ever increasing popularity of bonds for acquisitions is down to 1) low interest rates, 2) acquisition targets at attractive multiples (Medline was 14.7x based on pro forma adjusted EBITDA), and 3) private equity funds having a large treasure trove of cash to put to work. The attractiveness of multiples is moderating, with the average in US LBOs having risen from around 7x in 2009 to 10.6x in 2021 according to data from Credit Suisse and LCD, but for now that trend is being offset by large amount of dry powder sat with private equity firms.
So with that trio of factors still in place, what can we expect for Q4?
Looking around the market we are seeing issuance expectations of another $30-40bn for US high yield in October, so supply looks set to remain elevated. The big question for bond investors then will be whether demand will keep pace, and a healthy calendar of upcoming maturities, call dates and anticipated coupon refinancings suggests it should.
Maturities in US high yield total around $4bn per month for the next five months before a bumper $8bn in March, according to data from BofA Global Research, which also estimates around $20bn per month of potential calls, tenders and secondary market repurchases by issuers over the next 12 months. Another cash injection for investors will come from coupons on outstanding bonds, with BofA estimating that total at over $9bn in four of the next five months.
All things considered, we see potential for strong technical support for the US high yield market in Q4 and into 2022, and we will be interested to see whether these favourable conditions bring more large LBO deals out of the woodwork.