Outlook 2021: Lighter high-grade supply forecast after record volume; primary spreads recover

By Cristal Cody

Tupelo, Miss., Dec. 31 – Investment-grade issuers took a roller-coaster ride over 2020 as record volume hit the primary market.

More than $1.8 trillion of high-grade corporate bonds priced over the year, compared to $1.13 trillion of issues sold in 2019.

Investment-grade sovereign, supranational and agency bond supply totaled about $390 billion in 2020.

“Both numbers are 60% higher than last year's all-in totals,” said Ron Quigley, author of ‘Quigley's Corner’ and head of fixed income syndicate, primary sales and senior FIG/utilities banker at Mischler Financial Group Inc. “A record we might never see broken again! Bid-to-cover or oversubscription rates on new issues has been exorbitant especially when considering the historic volume numbers. Investors simply could not get new higher yielding IG credit product.”

Volume beat market forecasts most every month with numerous $100 billion-plus deal weeks.

Issuers built an estimated $500 billion of extra cash from debt offerings to shore up against the fallout from Covid-19 as unemployment rates hit double digits. In April, the U.S. unemployment rate soared to 14.7% from 4.4% in March. By November, the Labor Department reported the unemployment rate had declined to 6.7%.

The year also saw a record 35 debut issuers in the high-grade market, including Genuine Parts Co., Tractor Supply Co. and Galaxy Pipeline Assets Bidco Ltd. to pay down revolvers and other credit facilities, BofA Securities, Inc. analysts said.

“IG Credit markets well absorbed the historic supply total from investment grade-rated corporate bond issuance in 2019,” Quigley told Prospect News.

“Motivated by the pandemic and uncertainties surrounding its outcome pushed investors into the safe haven of U.S. Treasuries while the Fed kept rates unchanged,” he said. “As a result, there was a never before witnessed event in credit markets that created a historic low rate environment due to record smashing pandemic induced unemployment. Corporations, realizing that global investors were starved for yield with nowhere to put their cash to work, began issuing in large amounts to forward fund and take out higher yielding debt at lower rates.”

The Federal Reserve is not predicted to hike rates until well after 2022, sources note.

The target range for the Federal Funds rate was left unchanged at zero to 0.25% at the Fed’s last monetary policy meeting of 2020 in December until labor market conditions have reached maximum employment levels and inflation has risen to 2% and is on track to moderately exceed 2%.

Fitch Ratings reported in December that it does not expect U.S. economic activity to return to pre-virus levels until the fourth quarter of 2021 with unemployment levels projected to remain above 6%.

Supply in year ahead

The New Year is expected to bring lighter supply but remain strong with issuance ramping up in January.

Issuance is expected to range in the $125 billion to $135 billion area in the first month of 2021, syndicate sources said.

About $1.1 trillion to $1.35 trillion of high-grade corporate bond issuance is anticipated for the year, with supply likely front-loaded in the first half.

J.P. Morgan Securities LLC expects net supply to drop 40% year over year to $1.18 trillion in 2021.

BofA Securities analysts expect as little as $900 billion to about $1 trillion of investment-grade gross issuance next year, the lowest annual volume since 2012.

High-grade issuance “is forecast to be very weak,” according to BofA Securities analysts in a December report.

“First, volumes were on a declining path before Covid-19 came as corporate balance sheets have limited additional debt capacity consistent with IG ratings,” the analysts said. “Second, industrial companies are sitting on a $500 [billion] war chest of cash to defend against negative consequences of the coronavirus they do not need. Third, after the great refi trade, IG companies have made significant progress in terming shorter maturities into the back end of the curve.”

The virus’ impact on the globe is expected to continue through at least the first half of 2021 until vaccinations become more widespread.

“It looks like the virus situation is going to improve. That’s going to give companies confidence to return to normality in the summer,” Hans Mikkelsen, head of U.S. high grade strategy at BofA Securities Inc., said in a press conference in December.

S&P Global Ratings reported in December that it expects global bond issuance to finish up 16% in 2020 and decline about 3% in 2021.

Light M&A volume

Not much bond volume is expected from mergers-and-acquisitions-related financing in 2021, with the bulk of deals likely to be equity financed, according to Mikkelsen.

“We’ve seen that in the energy sector,” he said. “If you look at M&A volume in the first few years after a recession, very few companies have the balance sheet capacity to issue a lot of debt through M&A.”

BofA Securities expects M&A-related issuance to stay roughly flat in 2021, following a move lower to $113 billion through early December from $218 billion in 2019.

The pipeline of announced deals with potential high-grade bond funding requirements totals about $220 billion, below the $370 billion average in 2019 and $530 billion average in 2018.

However, some sectors have fared better than others in the post-Covid-19 world, and those could see M&A deal activity, sources said.

“The impact of Covid-19 has been relatively muted across the utility sector,” Quigley said. “Although commercial and industrial demand has been impacted, it was more than balanced by an increase in residential demand for power during this work-from-home year. Support at the state, local and federal levels for Covid-related power impacts have been strong, so that has also cushioned the sector – which is inherently a defensive sector to begin with.”

Environmental Social Governance issuance is expected to continue in the utility and financial sectors in 2021 as it replaces deals previously known as diversity and inclusion bonds.

NRG Energy Inc. was the first North American company to issue a sustainability-linked bond in 2020 and the first issued by any energy company outside of Europe, according to a market source and a company news release.

The company sold $1.4 billion of senior secured first-lien notes (Baa3/BBB-) in two tranches on Nov. 17 that included $900 million of 2.45% sustainability notes due Dec. 2, 2027.

Aggressive pushes into clean and renewable energy and carbon footprint reductions are expected under the Biden presidency.

Higher corporate taxes also are anticipated under Biden, but that’s a positive since “it will actually help utility credit metrics as the sector will be able to lobby for rate increases,” Quigley said.

Ratings downslide

The high-grade ratings downslide began soon after the pandemic’s start in March but slowed by year’s end.

Net downgrade volumes declined to $2.2 billion by mid-December versus the peak net downgrade level of $538 billion during the two weeks ended April 3, 2020, according to BofA Securities.

Fallen angels totaled $152 billion since the start of March, compared to $160 billion forecast.

“As we have argued, the rating agencies likely used assumptions too pessimistic about the negative impacts of Covid-19 when they downgraded en masse earlier in the year,” the BofA analysts said.

At the sector level, banks/brokers had the most downgrades since the end of February at $266 billion, or 23% of the total, followed by energy with $197 billion and autos at $147 billion.

Only about $10 billion of fallen angels are forecast in 2021 with as much as $80 billion of rising stars expected as high-yield companies “realize the value of potentially getting bailed out by the Fed in IG,” according to BofA Securities.

The Federal Reserve’s emergency primary and secondary market corporate credit facilities created under the Cares Act for high-grade corporate bond purchases to stimulate the economy are scheduled to expire at the end of 2020 but are expected to be reactivated or similar programs formed if needed.

The programs act as permanent back credit stops, Mikkelsen said.

“We think the downgrade risk is much less,” he noted. “If you’re a company now rated investment grade, you can get bailed out.”

Pricing levels mixed

New issue spreads moved out in the spring at the start of the pandemic but recovered ground by the fall.

Portland General Electric Co. (A1/A) priced high-grade issues twice over the year, selling $200 million of 30-year bonds in April and $230 million of bonds in two tranches in December in private placements.

The company issued $200 million of 3.15% first mortgage bonds due July 15, 2030 on April 27, 2020 at a spread of Treasuries plus 240 basis points.

On Dec. 10, the company placed $160 million of 1.84% first mortgage bonds due Dec. 10, 2027 at a spread of Treasuries plus 120 bps and $70 million of 2.32% first mortgage bonds due Dec. 10, 2032 with a 145 bps over Treasuries spread.

“We did our first issuance this year in April and spreads were really wide,” Katie Trosen, principal treasury analyst at Portland General Electric, told Prospect News. “This last issuance, we noticed spreads have tightened. While we’re still seeing a slight recovery in the economy at this point, spreads are not back to the pre-pandemic spreads, but they’ve tightened significantly from where they were back in March, April, May. Almost a hundred basis points lower.”

In 2019, the company sold $270 million of 30-year first mortgage bonds in two tranches in its lowest 30-year coupon in its history.

The deals included $110 million of 3.34% notes due Oct. 15, 2049 issued on Oct. 25, 2019 at par to yield a spread of Treasuries plus 130 bps and $160 million of 3.34% notes due Jan. 15, 2050 that were issued on Nov. 15, 2019 at par to yield Treasuries plus 130 bps.

The record high-grade deal volume in the primary market has been easily absorbed by the market.

“Investors are still hungry if you have a good credit rating,” Trosen said. “We were oversubscribed on both of our issuances.”

The company expects to return to the primary market early in 2021 with an issue and then again in the third or fourth quarter of 2021.

Issuers in Covid-19-impacted industries saw weaker pricing levels continuing late in the year.

On Nov. 17, British Airways plc priced $1,004,621,000 of enhanced equipment trust certificates in two classes in a Rule 144A and Regulation S deal.

The deal included $763,514,000 of class A certificates due Nov. 15, 2032 (A/A-) priced at par to yield 4.25%, tighter than price talk at the low 5% area, and $241,107,000 of class B certificates due Nov. 15, 2028 (BBB/BBB) sold at par to yield 8.375%.

The class B tranche was talked to print at the low 9% area, more in line with Caa1/B- issuers.

Mikkelsen told Prospect News that he “did indeed see high coupons in IG for Covid-19 impaired names like British Airways, but with several vaccines being rolled out globally even these names will be able to issue at much lower coupons. Obviously still much higher than sovereigns.”

Heading into December, Bank of New York Mellon Corp. saw historic lows for financial coupons and yields with its $750 million of 0.35% senior medium-term notes due Dec. 7, 2023 (A1/A/AA-) that priced on Nov. 30, a source said. The issue was sold at 99.893 to yield 0.386%, or Treasuries plus 20 bps.

Spreads to test tights

Covid-19 death totals, hospitalization rates and infection counts all were growing headed into the year’s end with many projecting higher numbers in the first two months of 2021.

However, prospects for the high-grade outlook were improving with the vaccine roll-out in December and other vaccines expected with more normal business operations anticipated for as early as June, the BofA Securities analysts said.

Investment-grade corporate credit spreads tightened by the year’s close to 116 bps in the ICE BofA US Corporate index, below the 137 bps historical median.

Corporate credit spreads came in to 107 bps by December from the wides of 401 bps in March versus 101 bps to begin the year.

Investment-grade credit spreads are forecast to begin 2021 at 110 bps and then trade in a 90 bps to 130 bps range in the New Year, according to BofA Securities.

Credit spreads are expected to “test the tight end of the range at the beginning of the year,” Mikkelsen said.

© 2015 Prospect News.
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