US Credit shows healthy supply and demand dynamics
US corporate bond primary markets have had a robust start to the year as both Investment Grade (IG) and High Yield (HY) companies have looked to take advantage of the recent rally in rates and spreads that we have experienced since Fed Chairman Powell's December FOMC comments up until his more cautious stance in the January meeting. And, although ultimately rates have been range bound, borrowers have been eager to take advantage of the window markets have provided to lock in lower interest costs, while investors have been keen to invest before policymakers are expected to start cutting interest rates sometime in Q2. Whilst January is typically one of the busiest months of the year for new issuance, we are witnessing levels that have not been seen in recent times.
Starting with IG, YTD supply has been $239.4bn according to Bank of America, representing a 30% increase year-over-year, with issuers flooding the primary market over January in particular and pricing $196bn in gross supply for the month, making it the busiest start to a year on record.
From an investor’s point of view, despite the impressive rally in December, we think yields in credit remain very attractive and investor appetite is seemingly strong as the market has shown little sign of indigestion given order books have been well oversubscribed. In fact, three of the top five biggest IG non-financial corporate deals of January; IBM, Energy Transfer and T- Mobile, all had order books in excess of $20bn and were multiple times oversubscribed as investors sought to lock in yields and reach for duration with the majority of demand lying in the 7-10y and 10+y tranches across the three deals. This avid demand for paper has led issuers to be able to price at tighter levels than initial price talk with very little new issue concessions being seen.
Turning our attention to the other end of the credit quality spectrum, and perhaps the most notable highlight of January was seen in the high yield new issue market. Capital market activity increased approx. 135% month-over-month to the highest total since November 2021 where 42 bonds priced $31.6bn during January 2024. Refinancing activity led in terms of use of proceeds, amounting to $25.7bn or 81% of gross volume. This was the heaviest refinancing activity for HY bonds since May 2021 as issuers actively looked to address their maturity profiles with little market indigestion seen here as well. Of the $25.7bn, 74% of new issuance was in B/CCC rated companies with the notional volume of bonds that need to be refinanced in 2024 down to just $25bn, of which the majority is BB rated. In tandem with HY, leverage loans have also seen rampant refinancing as leveraged finance has also looked to take advantage of this favourable time to push their maturity wall further out. In aggregate, we still have just 9% of US HY and 8% of the loan market maturing over the next 2 years as we move into the 2026 timeframe. An environment that should bode well for a relatively benign default rate if projections are to be believed.
When looking to February, most syndicates are forecasting a similar story to January for both IG and HY. As an example, IG supply consensus is in the $150bn context (vs. the previous 5yr average of $114bn), as a number of factors should support heavy issuance volumes in February as more companies exit their earnings-related blackouts periods, investor demand is expected to remain strong and borrowing costs to continue to look attractive vs. the levels available over the majority of 2023. If $150bn should materialise, it would represent the largest two-month period the IG primary market has seen (ex 2020 Covid months) eclipsing the previous record set in March/April 2022 ($346.4bn).
It is evident that capital markets are wide open across the rating spectrum. The new supply is being met with strong demand as investors look to lock in yields and issuers continue to address oncoming funding obligations in what looks to be a very supportive credit landscape creating a healthy supply demand dynamic. We also note that B-/CCC new issues have been received with enthusiasm. This is a notable change from only a few months ago and we think it is a very important development as history shows defaults usually come from this cohort. Maturity walls at the lower end of the spectrum are being addressed in the context of default rates creeping towards the long-term averages but with no unexpected spikes. With YTD inflows into both IG and HY and a further $6.02tr sitting on the sidelines in money market funds waiting to be deployed, we’d wager demand for corporate credit will continue to be strong which highlights the attractiveness of credit and fixed income markets. Waiting for a better entry point to invest might be a painful wait indeed in this context.
