By Yoruk Bahceli and Tom Arnold
(Reuters) – Junk-rated and emerging-market companies look set to raise record amounts of debt in coming months, urged on by bankers who advise taking advantage of funding markets before Treasury yields rise and push up borrowing costs.
February’s bond selloff gave companies a taste of the kind of market volatility they may face when Treasury yields, the reference rate for global borrowing costs, rise in earnest. Ten-year yields rose 80 basis points in the first quarter, climbing above 1.77% before easing last week to around 1.5%.
But even after the sell-off, corporate debt yields remain near all-time lows, so borrowers are hurrying to refinance existing debt. With the Federal Reserve broadly expected to taper stimulus from 2022, borrowing costs could rise above 2% by year-end.
“Volatility and the sharp upward moves in yields served as a gentle reminder that low base rates weren’t necessarily going to be here forever. That motivated borrowers to start thinking about (refinancing) if they hadn’t already,” said Chris Munro, head of global leveraged finance at BofA in New York.
Even as Treasury markets were roiled during the first quarter, junk-rated firms raced to tap markets and raised a record $205 billion, according to Refinitiv.
In the U.S. junk bond market, the world’s biggest, 77% of the issuance was aimed at refinancing, compared with 66% in all 2020. At $122 billion, refinancing volumes were the highest ever, JP Morgan estimates.
Leveraged loans, also used by junk-rated companies, saw $301 billion raised in the United States for the second-highest quarter ever, according to JP Morgan. With such loans, coupon payments rise when underlying interest rates go up.
Around 44% of the volume was from repricings, which allow borrowers to lower the coupon on existing loans.
Emerging-market companies, also vulnerable to higher rates, raised a record $165 billion in the first quarter, JPM data showed, with a record 51% of proceeds going to refinancings.
“If it’s a sector that’s been severely impacted and you’re uncertain when your business is going to return to normal, there is probably a lot of security in knowing that you have opportunistically tackled your refinancing,” Munro said.
(GRAPHIC – EM, junk yields near record lows after Treasury sell-off: https://fingfx.thomsonreuters.com/gfx/mkt/rlgpdzjylpo/em%20hy%20yields%20chart.png)
FAR FROM OVER
Banks like JP Morgan and Goldman Sachs are reporting bumper first-quarter earnings, driven by booming capital markets activity and trading.
“We recommend issuers to accelerate issuance plans as U.S. Treasury rates are skewed to increase further and more market volatility may lie ahead,” said Stefan Weiler, head of CEEMEA debt capital markets at JP Morgan.
Weiler expects a record $500 billion in emerging corporate hard-currency debt issuance this year.
Junk bonds and leveraged loans will break records, too, BNP Paribas analysts reckon, predicting U.S. issuers will raise over $1 trillion across the two markets this year.
Munro at BofA said refinancing would remain high, though he also expects more acquisition financing.
“The economics of refinancing early still make a lot of sense for corporate clients and similarly a lot of financial sponsors are trying to refinance their capital structures,” he said.
Markets are pricing more price swings ahead, with implied bond volatility well above early-2021 levels.
The rush hasn’t swept up higher-rated companies, whose issuance fell 5% year-on-year in the first quarter, according to Refinitiv. Vast cash balances following last year’s funding spree could be the reason.
The incremental increase in Treasury yields is also less significant for investment-grade companies from a cost perspective, as their debt has an average maturity of over 10 years, said Shobhit Gupta, head of U.S. credit strategy at Barclays.
Longer maturities mean the amount of debt needing refinancing every year is low, so rising borrowing costs have less effect on those companies’ debt-servicing costs.
Even so, if issuers believe rates will keep going higher, some companies could “bring forward their supply and also perhaps change the nature of it a little bit, maybe issue longer-dated paper on the margin,” Gupta said.
(Reporting by Yoruk Bahceli and Tom Arnold, additional reporting by Marc Jones; editing by Larry King)
