Capital Markets Weekly: Debt Markets reopen with heavy supply but COVID-19 poses lasting market risks
Central bank intervention to counterbalance the economic damage from COVID-19 - notably the Federal Reserve's half-point rate cut - have boosted financial markets this week after last week's effective "freeze" in debt supply. Primary debt markets reopened successfully with a rush of supply and a sizeable IPO was completed, although equity markets remained volatile, and the flotation performed badly.
Debt market overview
This has been a week of two parts. Initially, markets were frozen by risk aversion generated by COVID-19 concerns, but activity has surged after the Federal Reserve's rate cut and other intervention.
Early in the week, data was released suggesting that sub-investment grade markets were being particularly badly hurt although media sources claimed that 10 US companies delayed plans to launch bond financings last week, given the sudden deterioration in credit sentiment.
We are aware that several US firms that had planned to refinance their bank loans seeking improved terms have delayed such initiatives. In addition, funds available for junk-bond investments have faced heavy outflows. According to the Financial Times citing EPRF data, investors withdrew USD6.8 billion from funds which invest in high-yield debt in the week to 26 February, the largest outflows in more than a year, in turn fueling asset liquidations adding to downward pressure in the segment. By the close on 28 February, the ICE/BOA high-yield US index had widened by a full percentage point in a week to an average margin of 462 basis points over UST.
As this week progressed, companies took advantage of improved sentiment - combined with lower reference rates - to rush debt supply to market.
By 3 March, both European and US debt markets regained stability: Lower Saxony mandated for a EUR500 million 15-year issue while Commerzbank launched a 10-year pfandbrief, going on to sell EUR1.25 billion. Honeywell sold a EUR1 billion two-part Euro-denominated deal including a 12-year tranche. In the US, the parallel improvement in credit sentiment was shown by seven firms launching issues, including American Electric Power selling 10 and 30-year debt, Sherwin-Williams also garnering 30-year funding, with McDonalds and Texas Instrument placing shorter-dated debt.
On 4 March, 13 high-grade deals were brought in the dollar sector, with World Bank in focus for having arranged a five-year financing despite the volatile conditions.
Also in focus was a USD4.25 billion four-tranche issue for Truist, the bank formed by the merger of BB&T and SunTrust. Even the junk bond market reopened: Science Applications International Corp, a technology company, raised a USD400 offering of eight-year debt, to help fund its purchase of Unisys Federal.
Emerging markets
Chilean power utility Colbún reopened the Latin American debt market, with the first deal in almost two weeks. It placed USD500 million of ten-year bonds at 3.335%, a 240 basis point margin over US treasuries.
Belarus is marketing for potential dollar and Euro-denominated debt but is not expected to undertake the sale immediately if risk aversion persists.
Nigeria is in the process of appointing banks for future issuance. It has requested Expressions of Interest to prepare financing of up to USD3.3 billion of international funding within 2020. Of this, USD500 million is to refinance Nigeria's 6.75% January 2021 issue with the remainder to help fund the country's budget deficit. Nigeria plans to seek concessional finance with the balance of its funding needs being met from the market, although the proposal includes the possibility that the full need is met by bond sales.
Dubai Islamic Bank postponed on 1 March its planned issuance of a U.S. dollar-denominated sukuk worth approximately USD750 million due to unfavorable market conditions.
Argentine regional borrower La Rioja failed to meet a USD14.7 million interest payment due on 24 February on its USD300 million 9.75% 2025 issue. In a Luxembourg Stock Exchange statement - where the bonds are listed - the province stated that the Province was affected by Argentina's wider problems and needed to reflect these limitations in a "responsible" manner.
Provincial Governor Ricardo Quintela is cited as suggesting that the non-payment will enable La Rioja to hold discussions with its bondholders during the 30-day grace period without entering default. The Province stated that "without prejudice to its intention to honor its debt coupon", the discussions with bondholders would start efforts to establish "sustainable" debt levels based on "realistic" objectives, in keeping with national goals. Juan Luna, head of the Province's cabinet, is cited by Pagina 12 newspaper as suggesting it would conduct negotiations "with great responsibility and care", wishing to address debt sustainability with "a lot of maturity".
Pagina 12 - and other Argentine media - suggest that similar problems are faced by other provincial borrowers. The former noted that debt service on provincial debt in 2020 totals USD2.257 billion, of which 62% is faced by Buenos Aires. After attempting delay to a USD307 million payment due in January, this eventually was cleared in full, but Buenos Aires faces a further USD547 million payment in July, by which time it hopes to have advanced with debt restructuring.
ESG
Standard Bank, South Africa's largest bank by assets, has raised a USD200 million privately placed 10-year Green bond, the largest Green deal to date in Africa, fully placed with International Finance Corporation. The deal, the bank's first Green issue, will enable it to offer longer-term lending for environmental projects. It stated that proceeds will fund renewable energy, energy and water efficiency and environmental building projects.
IFC's country representative, Adamou Labara, claimed that South Africa has the potential for USD588 billion of climate-oriented projects in the next decade, hoping the deal would "catalyze interest in green investments from other actors in the country".
Equity
On 2 March GFL Environmental raised USD1.425 billion from the sale of 75 million shares at USD19 each, versus its indicated range of USD20-21. It also raised USD775 million from the sale of "tangible equity units" with a 6% yield. Proceeds will repay existing debt due in 2022, 2023, 2026 and 2027. A larger deal had been withdrawn last November with demand forthcoming at pricing below the targeted range of USD20-24 per share. However, the after-market performance was weak: on 3 March the deal traded to a 17% discount and closed at USD17.75 (4 March).
Outlook and implications
Overall, bond markets have recovered from last week, with an impressive reopening of corporate supply in both the US dollar and Euro-denominated sectors. It is also a positive indicator that a sizeable IPO was completed - but a negative if unsurprising one that its early trading performance looks weak.
We assess that companies have made hasty progress to market debt, looking to benefit from new lows in reference rates - with the US 10-year Treasury breaching the 1% yield barrier - while capturing finance while it is available.
Given the growing scale of COVID-19 globally, however, we assess that the threats of economic and market dislocation remain severe. Given the clear prospect of lower growth, and widespread impacts to corporate activity, riskier asset classes, especially particularly heavily leveraged junk bonds, appear exposed, with the latter facing increased default risks. The relative resilience of emerging market debt so far is perhaps surprising, although some countries might act to substitute for interrupted Chinese production. Overall, the level of uncertainty for markets looks high going forward and remains heavily subject to the outbreak's evolution.
Our key forecasts are:
- The outbreak will have major implications for global economic growth, extending for a longer period than that associated with a brief epidemic.
- Economic fallout will not be limited to export-oriented sectors but will extend into domestic consumer confidence and consumption: in areas like tourism, it will take several quarters for bookings to revive, expanding impacts on individual companies.
- Monetary policy alone will not serve to revive economic activity where this faces significant physical limitations and supply chain impacts.
- COVID-19 disruptions will force governments to increase outlays on healthcare and ancillary services, while acting as a drag on fiscal receipts in affected areas, placing upward pressure overall on deficits and financing needs.
- Slower growth will imply tougher financial markets, notably for the sale of equities and riskier instruments: more junk-bond defaults are likely. The US energy sector appears an area of potential risk.
- Implications are likely to impact economic data and financial conditions into 2021, even if the outbreak itself abates faster.
Overall, while the degree of risk aversion will vary depending on the spread and impact of the outbreak, capital markets now face greater uncertainties in 2020 than the favorable scenario - particularly for debt - that had previously been assumed.