Debt capital markets enjoy record-breaking run

While a lot of deal activity has been put on ice in recent months, in one area of investment banking business has never been brisker.

According to Dealogic, global debt capital markets activity (not including high yield) reached $2167bn in the first three months of 2020 – the highest quarterly total on record. It continued to be robust throughout April and into May. Corporate and sovereigns, supranationals and agencies (SSA) desks have been working hard to keep up with issuer appetite, while simultaneously adapting to the majority of their staff operating from home.

Corporates seeking liquidity

“It’s been an extraordinarily busy time,” says Dan Botoff, managing director and US head of investment-grade syndicate at RBC Capital Markets. “The sheer number of different issuers coming into the market, nearing 200 between mid-March and the end of April – combined with volume of issuance – has been staggering.”

It has also been a bounce back from a pronounced period of market dislocation in late February and early March, as the scale of the crisis became clear. “Early on in the disruption, we saw a typical reaction during a liquidity or credit crunch,” says John Hines, head of high grade debt capital markets (DCM) at Wells Fargo. “We saw very little demand from investors for commercial paper and robust selling of short-dated corporate bonds as investors looked to raise cash. As a result, we saw the primary market pause in early March.”

But despite the volatile market conditions, the drive to access cash began to push issuers back into the market. What started as a slow trickle became a deluge by the middle of March as market confidence grew, and a string of record-breaking weeks and months for corporate bond issuance followed. In the US, corporate issuance reached $194bn and $226bn in March and April, respectively, while in Europe this was $56bn and $101bn.

Corporates’ appetite for raising capital has come as no surprise to bankers, however. Richard Zogheb, global head of DCM at Citi, says: “I haven’t been surprised by the level of supply. Whenever there is any significant market dislocation, it really encourages corporate treasurers and chief financial officers to reassess their liquidity. For the better part of the past decade it has been possible to be a little complacent about that.”

Souhail Mahjour, co-head of HSBC’s corporates and emerging markets syndicate for Europe, the Middle East and Africa (EMEA), echoes that sentiment. He observes that, in a time of such economic turbulence, “no corporate treasurer is going to be blamed for bringing in additional cash; one of the key metrics everyone will be looking at is the cash burn rate. No one has a full view of the bad news and there is huge uncertainty about when a lot of companies will be able to begin generating meaningful incomes again.”

But while a desire to raise cash on the issuer side may not have come as a shock, the fact markets have been able to absorb this level of supply is perhaps more unexpected.

Tightening spreads

Initially, there was a clear pricing incentive for investors to get involved, with many of the bonds issued in March coming with significant new issue premiums, given the challenging market backdrop, but this did not last. Mr Hines says: “In mid-March, we were seeing new issue concessions of 50–80 basis points, which quickly compressed to single-digit or zero concessions for well-known names. Spread markets have since rallied considerably and that has led to a very attractive financing environment.”

Spreads have tightened so much that some big names who went to market in March, such as PepsiCo and ExxonMobil, returned again in April for further issuance.

It is also notable how wide access to credit has been, with companies from a broad cross-section of industries successfully issuing since mid-March, even with many facing uncertain future prospects. At first, investor demand gravitated towards high-grade names in defensive sectors, such as consumer staples, but the market has since broadened out considerably.

Mr Hines says: “We saw demand initially taking shape for double-A and single-A, in the 10- to 30-year part of the curve. And as those credits performed well, market confidence increased and we started to see demand grow lower down the rating scale, including for triple BBBs.”

Mark Lynagh, co-head of debt markets EMEA at BNP Paribas, says: “If you pick out some examples of sectors particularly under pressure right now – for instance energy, certain real estate sectors or airlines – we have seen deals coming to market in all of these areas. I think there are very few areas that would not be able to access funding in the current market with the right structure for investors.”

Central bank boost

Many have attributed the fact that activity has remained so robust, even among the wider economic upheaval, to the actions taken by central banks. Mr Lynagh, for instance, says growth in capital markets activity “was accelerated by the measures taken by various central banks”. In the third week of March, both the European Central Bank and the Bank of England announced large scale bond-purchase programmes, covering both sovereign and corporate debt.

But the decisive moment was perhaps the US Federal Reserve’s March 23 announcement that it would be launching major new economic stimulus measures, including two new corporate bond purchase facilities, with one targeted at primary markets. This was an unprecedented move by the Fed, which has never in its history purchased corporate debt.

Many bankers have been impressed by the impact of the Fed’s efforts, particularly since it appears to have given the market a considerable boost even before it had begun to make any purchases.

With central banks stepping in, demand has held up well – though in mid-May, Andrew Menzies, global head of corporate DCM at Société Générale, said: “We are starting to see some price sensitivity, where investors are beginning to question whether there is enough spread to get involved in a deal, and this trend has accelerated in the past few days.”

However, he believes such drops in demand are likely to be relatively short-lived: “There may be some periods of investor fatigue owing to the large primary volumes, but once these are digested and secondary levels re-align post any softening, it is likely primary will get up and running again relatively quickly.”

Speaking to The Banker at a similar time, Andrew Karp, global head of investment grade capital markets at Bank of America, echoed this sentiment: “There is still plenty of demand, though investors are becoming a bit more discriminate. In March and April, there was a bit of a scramble to buy and that worked because spreads have now tightened.”

Covid-19 response bonds

Business has also been brisk on the SSA desk. As populations worldwide grapple with the Covid-19 pandemic, a wave of social bonds funding healthcare or economic response measures have been printed by supranational agencies such as the World Bank, the European Investment Bank and the Inter-American Development Bank, as well as several national agencies and sovereigns.

Social bonds – which fund projects with positive social outcomes – had previously been a relatively under-used category, especially compared with their better-known cousins green bonds. Many believe the world is now witnessing a defining moment for the social bond. There has already been a higher volume of social bonds issued in 2020 than came to market during the whole of 2019, and by the end of April 2020, there had been five times more social bonds issued than in the same period in 2019.  

“While we abhor the pandemic and wish it had never happened, it is a lightbulb moment, for many, in the context of social bonds,” says Martin Scheck, CEO of the International Capital Market Association, a trade body that also acts as the secretariat for the green bond and social bond principles. “We see it as an unfortunate catalyst, similar to the problem of climate change that had a global effect on green bond issuance.”

Farnam Bidgoli, head of sustainable bonds for DCM EMEA at HSBC, shares this view. She says: “I think previously there had been some scepticism about social bonds and what constituted one – unlike with green bonds, where it had always been really clear what their purpose was. But in the past couple of months we have seen a really clear and tangible demonstration of how social bonds can be of benefit.”

Frameworks in place

For issuers with existing social bond frameworks, which have already gone through external validation to ensure alignment with the social bond principles, it has been relatively straightforward to adapt these for issuance related to Covid-19. Stephane Marciel, Société Générale head of sustainable bonds, debt capital markets, says: “The largest volumes of Covid-19 issuance by supras and agencies has been coming from those issuers who already have social bond frameworks in place, so this type of issuance is not totally new for them and their frameworks already address the key points.”

Issuers without existing social bond frameworks have had to devise something new that will not only satisfy investors that it is of genuine social benefit in relation to the pandemic, but also allow them to get to market as quickly as possible. Given the time pressure, several issuers have opted to adopt frameworks that take influence from, but are not formally aligned with, the social bond principles.

Mr Marciel says: “We have seen some issuers take an alternative approach. For instance, Nordic Investment Bank and Bpifrance set up their own ad hoc frameworks, following the social bond principles except for the second party opinion.” However, he adds: “These issuers have committed to a high degree of transparency in terms of use of proceeds and reporting.”

The rapid expansion in social bond activity is likely to spur longer-term discussion about how best to ensure robust standards within the sector, as seen during the development of the green bond market, particularly as there has been increased corporate interest in this kind of issuance. Agnes Gourc, co-head of sustainable finance markets at BNP Paribas, says additional debate and attention within industry is positive. “I am quite hopeful that it is a breakthrough moment for the social bonds market. The Covid-19 related issuance has meant a lot more focus on this market, and a lot more heads together asking the questions and helping to build up longer-term confidence in the social bond ecosystem.”

Remote record issuance  

Looking at the sheer volume of bonds printed during this remarkably busy period, across both SSA and corporate issuance, it would be easy to forget it has all taken place when large parts of the workforce have been operating from home. Although several banks report that they have kept a few key staff in the office, typically on the syndication desk, most employees have been working remotely.

RBC Capital Markets’ Mr Botoff says: “The vast majority of the work behind all the issuances is being done from home and to that extent, this situation is fundamentally different to anything we’ve seen before. Ten to 15 years ago, that just wouldn’t have been possible.”

He adds: “It has gone exceptionally smoothly. Fundamentally, it can be easier to get things done when you’re able to be in physical proximity to colleagues, but people have become accustomed to managing things remotely. Initially, those background distractions that everyone is facing, like barking dogs or household appliances beeping, took a little getting used to, but it’s quickly become normal. Everyone understands we’re all in the same position.” 

Mr Karp echoes this view: “If you had told me we would have been dealing with the greatest volume of issuance we have ever seen when nearly everyone is working from home, I would have thought it would be incredibly challenging. Clearly that hasn’t been the case and it has gone smoothly.”

Familiarity helps

Although technology has been a key factor, Citi’s Mr Zogheb says another important point is that many of the recent issuers have been seasoned market participants. “For frequent issuers, it has been relatively easy to serve them from home, as they are very familiar with how everything works and have a sophisticated understanding of the markets.”

The situation is unlikely to change much in the short term. White-collar workers are unlikely to be leaving their home offices en masse any time soon. Issuance volumes are also expected to remain robust as corporates continues to seek to bolster their cash position and the pipeline of Covid-19 response bonds continues.

Mr Zogheb expects this pattern of issuance to start tailing off in a few months. “Once we get into the third quarter, I think we will have exhausted liquidity-related issuance, and what comes next will be a function of whether folks are in a position to consider increased capital expenditure as economies begin to open back up, or M&A activity,” he says.

“The hope is that as we transition to more episodic issuance, with new and infrequent issuers coming into the market, we will be able to start moving some people back into the office.”